Worldwide economic uncertainty has
created a growing interest in precious metals as a way to preserve wealth.
Today, global risks for investors include currency devaluation, sovereign debt
defaults, bond market collapses and stock market losses, all underpinned by
ever-increasing government debt.
For protection from impending
economic Armageddon, investors are turning in increasing numbers to the
traditional safe haven of precious metals. Unfortunately, many today don't know
how to purchase or store bullion, and consequently may find themselves as
vulnerable to financial collapse as those who didn't purchase any bullion at
all.
This increased interest in precious
metals as portfolio insurance has spawned a new generation of precious
metals-based financial products, many of which are paper proxies or derivatives
of bullion. There are even unregulated markets for the exchange of "digital
gold."
A
clear case for transparency
In 2007, former Bank of Canada
Governor David Dodge gave a speech entitled "A Clear Case for Transparency" to
the Canada-UK Chamber of Commerce. "...[I]investors will have to take on more
responsibility for diligent research," he said, "so that they can better
understand the nature of their investments and demand greater transparency where
it is now lacking ... they must do their own homework and make a concerted
effort to understand what they are buying."
Most investors do not read the fine
print of the agreements they sign with respect to financial investments; they
make assumptions, but do not definitively know if they own actual bullion. Some
are attracted to certain bullion investments because of low premiums and low
storage fees, but when was the last time Wall Street and the major banks gave
the investing public a deal?
Investors who don't do their
homework may be dismayed to find that their safe haven asset has proved to be
anything but. These same people perform rigorous due diligence when purchasing a
home, car or boat, demanding that they have clear legal title to the asset in
question. The same attention to detail must be paid when investing in
bullion.
The most important concept to
understand is that a financial institution CAN sell an investor's bullion if the
agreement states that it can. Banks are not raiding allocated accounts; rather,
they are following the provisions of the contract, in which the bullion is not
allocated despite an investor's assumptions.
There does appear to be cause for
concern regarding the transparency of bullion products. As reported by the
economic news website ZeroHedge, financial services
giant Morgan Stanley paid out $4.4 million in June 2007 to settle a class action
lawsuit brought by clients after the firm charged them to "buy and store"
precious metals, but did neither .
Similarly, a class action lawsuit
filed in New York's federal court accuses UBS Financial Services of misleading
silver investors, and charging them storage fees for metals that were never
purchased, let alone allocated or stored for them.
A larger problem has been brewing
for several years now, that of exchange-traded funds (ETFs). These are generally
viewed as a low-cost panacea that replaces almost any investment strategy,
including the purchase of gold bullion, and they are giving investors a false
sense of security.
False
sense of security for ETF investors
ETFs started as equity index
vehicles, in which brokers acting as Authorized Participants borrowed shares
from institutions, hedge funds, mutual funds or their clients' margin accounts
to contribute to the Origination Basket of shares. They received ETF shares at
Net Asset Value (NAV) in exchange, and sold them to investors at NAV - keeping
all of the money. This is standard practice, as brokers have always been able to
borrow shares from clients' margin accounts for the purpose of shorting or for
lending to other brokers.
Essentially, many ETFs hold assets
that have been borrowed. Because there are no specific prohibitions to prevent
the same practice from being used in precious metals ETFs, the same methodology
is likely being used. Many investors are attracted by the low management fees
offered by precious metals ETFs, but few understand the problems that may arise
when more than one person has claim to the same asset.
ETF-based financial crisis could make 2008 look like child's
play
This ETF structure will work during
normal market conditions. However, it may result in losses and disputes if the
Authorized Participants, acting as market makers, become insolvent or step aside
during a precipitous decline. If a bank or brokerage firm becomes an insolvent
Authorized Participant, either the lender of the assets or the ETF shareholders
will suffer losses. During a market crash, existing holders may be unable to
sell their ETF shares. Although this possibility was considered remote when ETFs
were created, the recent and recurring failures of banks and brokerage firms
make these concerns far more real .
The bottom line on ETFs is that
they are tracking vehicles with multiple claims/counterparty risks on their
assets as well as their shares. As debt-based stress on the global financial
system continues to build, the flash-crash of 2010 may well have foreshadowed an
ETF-based financial crisis that will make the subprime mortgage crisis of 2008
look like child's play.
Own
bullion with clear title
When we at Bullion Management Group
sit down with clients seeking to own bullion, we present them with our Precious
Metals Pyramid Chart. Moving up the pyramid increases risk; moving down the
pyramid increases safety. A portfolio's foundation should consist of physical
bullion owned outright.
Farther up the pyramid are proxies of bullion in one
form or another that are more risky and often less liquid; in other words, the
opposite of a safe haven asset you can count on in times of financial stress.
Bullion should always meet two criteria: It should not be someone else's
liability, and it should not be someone else's promise of
performance.
To establish a physical bullion
portfolio foundation with metals that are stored on an allocated and insured
basis, one that will protect against what could be called ethical mayhem in
today's financial sector, investors must, as Governor Dodge advised, make a
concerted effort to understand what they are buying. While reading legal
documents and prospectuses is tedious, the truth is in the fine print and
investors must do their own due diligence, and beware of complex investment
structures.
Demand
documentation that transfers title directly to the purchaser
For a bullion product, be it a fund
or actual bullion bars, to earn its place as the foundation of a portfolio, the
bullion purchaser must demand documentation that legally transfers title of
specific, physical bars directly to them. Do not accept IOUs, paper proxies or
derivatives. It is important to read the purchase documents carefully to ensure
they convey legal title. Only after the purchaser has legal title can they enter
into a binding custody agreement for bullion storage on an allocated, insured
basis. In that agreement, the purchaser must be able to identify all terms and
rights concerning insurance and secure, allocated
storage.
Proper insurance and allocated
storage in a credible, guarded vault costs money, so steer clear of bullion
products promising low fees. If the deal appears too good to be true, the
physical bullion may not exist.
What the investor may have is paper bullion that
will not offer protection when it is most needed; they may simply be an
unsecured creditor of the dealer. It is hardly prudent to be tempted by low
storage fees that will save a fraction of a percentage point while risking an
entire bullion holding. Short cuts and penny pinching are inadvisable strategies
for any asset intended as an ultimate safe haven of wealth
protection.
Home
storage not worth the risk of invasion or physical assault
Many people think that storing
their bullion at home is a good way to economize on physical bullion storage
fees, but be aware that any sizable amount of home-stored bullion will not be
covered by a household insurance policy.
Keeping a modest--and secret--stash
of small-denomination gold or silver for barter purposes is recommended in the
event that ATM machines aren't working, or a 'bank holiday' is announced. This
may seem like an excess of caution until you consider that, earlier this year,
the Bank of Italy authorized the suspension of payments by Bank Network
Investments Spa (BNI) without first advising depositors
.
Unless absolute secrecy is
maintained, home storage means putting yourself and your family at risk of a
home invasion. There has been an increase of home invasions in England during
Asian wedding season, when gold gifts are stored in homes, and street gangs and
professional thieves are only too happy to relieve people of their precious
metals .
Even in peace-loving Canada, a
British Columbia man lost his life savings of $750,000 in silver bars to
knife-and-gun wielding thugs who arrived at his door disguised as police
officers. When he let them in, the 'officers' forced him to open his vault and
stole the silver . For any sizable amount of bullion,
home storage is clearly not worth the risk.
Many precious metals dealers do not
trust banks for storage, and prefer private vault facilities. They may rethink
this approach on reviewing a British case where authorities raided three private
safe deposit box centres, and opened 6,717 private
boxes . The owners of the boxes were required to
provide proof of the contents of their box before their possessions were
returned.
Most could not do so, and much of the cash involved went missing while
other items are in dispute. The ensuing litigation will likely last for decades;
in the meantime, those who stored bullion in their boxes have been relieved of
their metal, and may only receive compensation in the amount of the value of the
bullion at the time of the raid.
Another consideration is that safe
deposit box contents cannot be insured, and there is no proof that anything is
actually in the box. Investors who are still interested in private vaults or
safe deposit box centres should perform due diligence
on the financial condition of the operator and the owner of the vault, since
stored assets may be at risk in the case of a private vault's
insolvency.
Storing bullion at home, in a safe
deposit box or in a private vault is another form of false economy, wherein
investors put their safe haven asset at risk to save a small amount in storage
fees.
LBMA
bullion in LBMA member vaults
Another important aspect of due
diligence for a proper foundation of wealth preservation is the assurance that
your bullion is in the form of Good Delivery bars, and stored in the vault of a
London Bullion Market Association (LBMA) member.
The LBMA is a wholesale,
over-the-counter market for trading gold and silver. Its members include the
majority of the bullion banks that hold gold, plus producers, refiners,
fabricators and other traders throughout the world.
The reason for insisting on LBMA
bullion is that it assures the purchaser of the quality and fineness of the
bars. Once gold is outside a chain of integrity such as that of the LBMA, it may
need to be re-assayed before it can be sold. This prevents gold-plated Tungsten
bars from entering the chain of integrity.
Re-assaying is time consuming,
engenders extra cost and once again defeats the purpose of a safe haven store of
wealth that offers efficient liquidity.
We constantly hear stories of
discount bullion, or bullion sold at no premium to the spot price. The
likelihood that this is pure bullion from an ethical source is slight to
none.
In
case of fire, you need an extinguisher, not a picture of one
Bullion demand is clearly growing
as both sovereign nations and the world's largest financial institutions buckle
under the burden of unserviceable debt, leaving helicopter-loads of new money
printing and associated currency devaluation as the only way out.
Investors can protect their
portfolios by purchasing physical bullion. Just as with any large asset
purchase, demand documentation that confers legal title to the bullion you are
purchasing, review a written custodial agreement that specifies insured,
allocated storage without giving the custodian the right to deal with the
bullion in any way, and insist on Good Delivery bars.
When the next financial firestorm
erupts, you need real, physical bullion and not a paper proxy; just as in a fire
you need a real fire extinguisher, not a picture of one.
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