Most gold owners only worry about theft. But there are other risks associated with gold ownership, that are far more likely to impact your property rights. In the following we explain the main issues that you need to be aware of.
Theft and disappearance
Irrespective of where you store your precious metal, there is always the risk of theft or disappearance. There are numerous examples of people, who hid gold in their house or garden, and later could not recover it. Others had their metal stolen, despite the use of state-of-the-art safety boxes. Australian media mogul Kerry Packer was one of them. In 1995 he found out, that 285 kg of gold had been stolen from the hidden safe in his Sydney headquarters.
Large storage facilities are not immune to theft. For instance, 3 tons of gold bullion were stolen from the Brinks Mat security warehouse near Heathrow airport in 1983, and robbers managed to get away with 750 kg from a Sao Paulo airport terminal in 2019.
Governments have a history of being successful gold plunderers. It is estimated that from 1939 to 1945 the Nazis stole 1,038 tons from various European countries, and the Japanese looted 6,600 tons from China in 1937
Enhanced security measures can protect against theft. If you keep your precious metal at home, you can install a high-tech security system. But the costs are prohibitive for the ordinary investor and the installation might make criminals aware of valuables stored in your house. Operators of vaults and safe deposit boxes have invested a lot of money in security hard- and software. But even the most sophisticated systems can be defeated, especially if there is inside help which is often the case. Additional insurance is therefore recommended.
Counterfeits have been around since gold became a store of value and means of payment. Most fake coins and bars are made from tungsten and plated with a gold. Improved production technologies have made it increasingly difficult, to spot the difference between genuine and fake, without having access to expensive testing equipment.
Investors who buy gold on the internet or from a small gold shop run the risk of spending a lot of money on a product, that is worth only a fraction of its purchase price and unsellable, except if they lie and pretend to own genuine gold.
Most of the large gold dealers claim to purchase directly from refineries, that are certified by the London Bullion Market Association (LBMA). But the ordinary buyer can’t verify this and even if it is correct, who guarantees that all employees of the refinery, the transportation company and the vault are playing by the rules.
Kingold Jewelry, a Chinese company listed on the Nasdaq since 2010, provides an excellent example, that even large institutions can be fooled. The company provided 83 tons of gold as collateral to secure USD 2.8 billion in loans from several Chinese financial institutions. When Kingold failed to repay some of its loans at the end of 2019, the collateralized “gold” turned out to be nothing but gold-plated copper.
The best way to deal with counterfeits is to purchase directly from reputable refineries and carry out 100% testing of all bullion. This is hardly done for cost reasons. Therefore, it is probably safe to assume, that some gold stored in vaults is fake.
Fraud can happen in various ways. Gold brokers and storage providers can take your money without purchasing and storing gold, or they can lease or rehypothecate it without your knowledge.
In 2019 Charles McAllister, former CEO and owner of once-popular U.S. firm Bullion Direct, was convicted for defrauding customers out of USD 16 million. Between 2009 and 2015, he had pretended to use customers’ money for the purchase and storage of precious metals, when it was in fact used to pay for corporate expenses or even for McAllister’s own personal benefit.
Another example is Northwest Territorial Mint. Between 2009 and 2017 its president and vault manager allegedly defrauded 3,000 customers of more than USD 25 million with false promises about bullion delivery and storage. According to the U.S. Attorney’s office, “by at least 2012, the company lacked enough assets to fulfill customer orders and used new customer money to pay off older customers in a Ponzi-like scheme”.
There are many similar stories. Most of them don’t become front page news, but are covered up for various reasons. However, if you dig deep by researching specialized fraud prevention websites, you find a lot of interesting information. Not all cases are outright fraud, but at least there is a lot of incompetence or irresponsible behavior involved.
Regular insurance does not provide protection against fraud. Policies only cover loss or damage, and perhaps mysterious disappearance and employee infidelity. If a lower employee commits fraud, this might be covered under certain conditions. However, we doubt that the insurance will pay, if senior managers of the storage company engage in illegal activities, and there certainly is no coverage for the “loss” of bullion that was never acquired and never entered the vault.
Fully independent external audits can prevent fraud or at least identify it at an early stage, before all assets are gone. Unfortunately, they are the exception. Traditionally storage companies select and pay audit firms to examine their finances and bullion inventory. This enables them to influence the outcome of the reports.
Like all other companies, gold storage providers can go bankrupt. In case that you have a direct contract with the vault operator for segregated storage and can prove your ownership with a fully paid invoice, you should be able to reclaim your precious metal quickly. However, if you are the owner of allocated gold, the liquidator might refuse your claim which could lead to a lengthy legal battle. With unallocated storage, you are just an unsecured creditor and stand to lose most if not all of your investment.
Ordinary investors usually don’t have a direct contract with the vault operator. They contract with a bullion dealer, that arranges for the storage in a third-party vault. The dealer might even use the services of an intermediary, resulting in a chain of contracts and multiple counterparty risks. Under such a set-up, the recovery process can take months, even for gold held in segregated storage. At the end investors might only receive a fraction of the true value of their bullion and be paid in fiat currency like the USD or EUR.
To protect oneself against bankruptcy, it is recommendable to have a direct contractual relationship with the vault operator and store precious metal in segregated form. Bullion allocated and pool allocated storage, to a lesser extend also weight allocated storage, are fine as long as fraud is not the cause of the bankruptcy. Unallocated storage should be avoided. Alternatively, storage at home or in a safe deposit box offer protection.
No physical withdrawl
If you are the legal owner of gold, you should be able to take physical possession of it, either by picking it up from the vault or by having it shipped at your cost to an address of your choice (e.g. another vault or your home).
Many products don’t permit physical delivery, or only under severe restrictions and after paying high additional fees. This is still acceptable, as long as you get paid an adequate price in fiat currency. But what happens, if a financial crisis emerges and the issuer decides to discontinue the product and pay out every investor? In this case you might end up owing (worthless) fiat currency instead of gold, while the price of the precious metal soars to previously unthinkable levels.
Many buyers of financial gold products have experienced problems with physical delivery. One such case involved Xetra-Gold. The product is a bearer note issued by Deutsche Börse Commodities GmbH, a joint venture between German stock exchange Deutsche Börse AG and German banks Commerzbank, Deutsche Bank, DZ Bank, and Swiss-based Bank Vontobel. The fund used to claim that “for each Xetra-Gold bond, exactly one gram of gold is deposited in the central vaults for German securities in Frankfurt” and that “investors always have the possibility of demanding delivery of the securitised amount of gold”. In 2016 a customer of Deutsche Bank was denied physical delivery even though the “gold” assets managed by Xetra-Gold were valued at EUR 3.5 billion at the time.
It took Deutsche Bank a while to officially comment on this and when they did their statement included the following remark: “If in specific cases the request of the investor for physical delivery of gold cannot be accommodated immediately this will be investigated and an individual solution with the investor will be found”. That sounds very reassuring, doesn’t it?
Customers of bullion dealers offering allocated and even segregated storage have also faced problems with physical delivery. Usually their gold is stored in the vault under the name of the bullion dealer and not their own name. Without explicit instructions from the bullion dealer, the vault will not release any metal stored there.
We won’t be surprised, if a lot more cases of denied physical delivery will surface in the future. Once again, the best way to ensure that you own gold, is to buy it directly and store it at home, in a safe deposit box or segregated in a vault.
Paper claim instead of physical ownership
Many financial products claim to provide direct exposure to gold. There are Gold Derivatives, Gold Certificates, Gold-ETCs (Exchange Traded Commodities), Gold-ETNs (Exchange Traded Notes), Gold-ETFs (Exchange Traded Funds), Bank Sponsored Gold Funds, Gold Close-Ended Funds and many more mixed products. A lot of investors, who have bought such products, think that they own gold. But in fact, they only have a claim against the issuer equal to the corresponding value in fiat currency.
Some “gold” products just track the price of gold, but are not backed by any physical metal. Other products claim to be invested in gold, but they only maintain a small stock to satisfy the occasional customer, who asks for physical withdrawal. If many customers want their gold at the same time, they will be unable to deliver it.
Even allegedly “safe” products offered by banks may not live up to customer expectations. In the Silberblatt vs. Morgan Stanley Class Action lawsuit in the USA the plaintiff claimed, that Morgan Stanley’s customers were “misled into believing that specific bars or units of precious metals were allocated to them and, therefore, not subject to claims of creditors of defendants.” The bank denied allegations, but decided not go to court and instead settle for a USD 4.4 million payment in 2017 “to avoid the cost and distraction of continued litigation”. We leave the interpretation of this statement to the reader.
Irrespective of what your bank manager or your financial advisor tells you, always request and read the product prospectus. The document should confirm, that 100% of the gold is held in segregated storage, that it is not included in the issuer’s balance sheet and that you have the right to physical delivery any time and irrespective of volume. But even then, you can’t be sure that you really own gold. The best way to ensure this, is to buy it directly and store it at home, in a safe deposit box or segregated in a vault.
Leasing and rehypothecation
Gold does not yield any return but causes storage costs. Consequently, two methods have been developed to earn income on gold or commercialize it in another way.
Gold leasing enables the owner to earn money by allowing the lessee to use the gold temporarily on the condition, that interest is paid and the gold or its equivalent is returned in the future. This is a wide-spread practice and even central banks engage in it, when they lend gold to one of the so-called “bullion banks”.
As long as the lessee returns the gold, gold leasing is a great way to make some extra money. But what happens, if the lessee defaults or commits fraud? As long as the gold is still within the premises of the lessor, there will probably be a prolonged legal battle on who actually owns the gold. If the gold has left the vault of the lessor, there is a very high risk, that it will never be seen it again.
Gold rehypothecation is another way to commercialize gold. It occurs when the storage provider pledges gold as collateral to secure a loan (e.g. to purchase more precious metal, to extend storage facilities, or pay for running expenses). In case that your storage provider defaults, you will certainly have problems to reclaim your metal and there is a very high probability that you won’t succeed.
The leasing and rehypothecating of “your” gold are legal, as long as the storage provider has reserved respective rights in its terms and conditions or the storage contract signed by you. Just check the details of the respective documents.
Even if leasing and rehypothecation is not specifically allowed, storage providers might still do it for allocated gold. They know from experience, that only few customers request the return of their metal in a given period. By maintaining a small balance of physical gold for delivery, they can engage in illegal leasing and rehypothecation for many years with a very low risk of being detected. The best protection against leasing and rehypothecation is storage at home, in a safe deposit box or segregated in a vault.
Sale below fair value
In the Western world there are two major organizations that determine the price of gold. The spot price is set by the London Bullion Market Association (LBMA). Its pricing is auction-based and a quote is provided twice on each business day, at 10:30 a.m. and 3:00 p.m. London time. COMEX in New York is the leading benchmark for gold futures. Its prices are determined continuously during trading hours, that are from Sunday to Friday 5:00 p.m. – 4:00 p.m. Central Time with a one hour break each day.
One would expect that the prices of the two exchanges don’t differ a lot. This is usually the case, but in times of crisis large discrepancies can emerge. For instance, on March 24, 2020, the spread between LBMA spot and COMEX futures, which usually is around USD 1.50 per ounce, blew out to USD 100 at one point during the day. Similar or even larger spreads between London and New York cannot be ruled out for the future. The emergence of the Shanghai Gold Exchange, that sets its own spot and future prices, is likely to cause additional disruptions.
There are numerous complaints, that the LBMA price is manipulated and that the COMEX price is based on “paper gold” instead of “physical gold”. A deeper analysis of this topic goes beyond the scope of this report. But as most big banks have accepted multimillion- or even billion-dollar fines for gold price manipulation, the fact can hardly be denied. It is also obvious that central banks have a strong incentive to keep the price of gold low, in order to distract people from the rapid decline in the value of the USD and other fiat currencies. Consequently, close cooperation between central banks and bullion banks is likely.
Ordinary investors, who want to buy physical gold, have to pay more than the “official” price, sometimes a lot more. Especially during economic disruptions, the premium for physical gold goes up significantly. If your gold storage contract stipulates, that you can sell your gold exclusively to your storage provider at the suppressed LBMA gold price, you might suffer serious losses. Expect them to be in the tens or even hundreds of dollars per ounce.
You can only avoid having to sell your gold well below fair value, if you keep it at home, in a safe deposit box or fully segregated in a vault. For allocated gold storage, the right to physical withdrawal must be guaranteed. In case that your storage contract does not grant this right, or only under very tough conditions, it is probably better to look for a better storage solution.
Governments have always considered gold as a strategic asset and have confiscated it during times of economic or monetary crisis. Well-known is the gold confiscation in the USA that lasted from 1933 to 1974. Per executive order 6102 President Roosevelt forbade “the hoarding of gold coin, gold bullion and gold certificates within the continental United States”. Citizens were required to sell their gold to the Federal Reserve in exchange for $20.67 per ounce. In 1934 the price of gold was raised to $35 per ounce, resulting in foregone profits of 69% for those, who had surrendered their metal.
Regulations severely limiting the free ownership of gold were also enforced in other countries, such as the UK (1966 – 1979) and Australia (1959 – 1974). As we live in the age of fiat currencies, that derive their value neither from gold nor any other asset, confiscation of the yellow metal is not very likely today. But as the coronavirus has shown, conditions can change very quickly and nobody can say for sure, that we are not heading into another era, where gold ownership will be severely limited.
If you are a citizen of country A, use the service of a bullion dealer from country B and have the gold stored in a vault in country C, you are exposed to confiscation risk three times. Assuming that just one of the countries involved issues respective legislation, you might be forced to hand over your metal at a price well below market rates or, in the worst case, without any compensation whatsoever.
For those living in a country with a high confiscation risk, storage of some or all gold offshore in a safe jurisdiction with a high regard for property rights, is the best protection against confiscation.
Some offshore providers have a confiscation protection clause in their contract. Such a clause stipulates, that in the event of gold seizure in your home country, your account is frozen so that no gold can be withdrawn. The clause can only be revoked by yourself during a personal visit to the offshore vault.
Whether such a clause is useful has not been tested. If your home country strikes a deal with the offshore country, and the offshore country then instructs your storage company to send your bullion to the confiscating country, the vault provider will have no choice but to comply. Without such a bilateral government agreement, your gold might be protected.
Disclaimer: The above is for informational purposes only. It is not an offer or advice to buy or sell any products or services. LBB and its owner do not provide investment, tax, legal, or accounting advice. Neither the company nor the author is responsible, directly or indirectly, for any damage or loss caused or alleged to be caused by or in connection with the use of or reliance on any content, goods or services mentioned in this article.
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