Gold and Silver... How Do I Own Thee?
On 5th of April Safe Haven posted an article by a James Macfarlane titled Gold and Silver... How Do I Own Thee?... Let Me Count The Ways.
On thing I really like about the article is the way he distinguishes between physical and paper. His position is that if you don’t hold the physical yourself, you have a counterparty exposure, period. It is a position I hold but have seen very few, if any, make this point. Reading stuff on the internet gives me the feeling that a lot of people seem to think that because allocated is involved in whatever they are buying that somehow it is magically super safe!
The article then comprehensively discusses all the various paper options in a fairly balanced way (unusual these days). However, there are a few inaccuracies in his treatment of the Perth Mint which I discuss below. I have emailed James with the comments below and he was happy for me to publish them here and he will review/respond. The sections quoted in italics are from the article.
I also think the article could breakdown the paper options in a bit more detail. My view is that the risk hierarcy of paper gold products would be (there would be sub risks within the categories depending on the associated legals and trustworthyness of the provider of the service/facility):
Segregated Allocated - physically segregated specific coins and bars (including numbers) in your name.
Unsegregated Allocated - physically segregated gold (usually in bar form) in the name of the storage service provider where title resides with the holders as a group but no one bit of gold is exclusively identified as owned by a specific holder. Examples would be GoldMoney, BullionVault, Central Fund of Canada. ETFs can be included if you believe they have the gold, although considering the lack of accountability in the legals of some they may not qualify for this category from a risk point of view).
Unsegregated Physical Backed - an unsecured claim on a provider where the claim is backed 100% by physical in various forms. This is the strict definition of the Mint's unallocated. No different to unsegregated allocated except that title to the gold does not directly reside with the holders. Has to be ranked below the one above because the lack of direct title means you are relying on no other problems in the provider's balance sheet, even if they have 100% gold. In this sense you have true counterparty exposure as commonly understood. In retrospect, the Mint should never have used "unallocated" as this is commonly understood as defined below, which is not what we do.
Unallocated Fully Hedged - an unsecured claim on a provider where the claim is fully hedged by one or all of physical gold, futures, options etc. You are relying on this ability to hedge this properly - physical gold 1:1 is a perfect hedge, anything else is less perfect as it may not be able to be timed exactly with actual liquidations.
Unallocated Unhedged - an unsecured claim on a provider where the provider may or may not hedge the exposure, eg just hold your cash if they think the price is going down, hedge it if they think it is going up, they keep all the profits, if they make losses you are relying on the strength of their balance sheet.
Anyway, my comments to the article are:
“An allocated account is very different. In an allocated account the bullion must exist, and the amount you purchase is stored in your name. You hold actual title to your precious metals. The dealer in this case is guaranteeing that it has the same amount of assets in bullion as there are claims against those assets.”
I would pick a technical detail with this statement about the dealer holding the “same amount of assets”. This is not the strict definition of allocated, which is specific bars or coins in your name. In its most common form, this means you have specific bar numbers allocated to you. This is different to what he then leads in to discuss regarding GoldMoney etc. In fact, allocated at the Mint (or another other depository, eg Delaware Depository) would have to be safer than GoldMoney type systems because clients have title to specific bars or coins, not an “undivided interest in” allocated bars (from GoldMoney’s user agreement). Being undivided, one could argue that GoldMoney is really an unallocated allocated system! I would suggest that for completeness and accuracy true allocated should be separated from “undivided interest in allocated” systems. This is not to say that I think there is any problem with the GoldMoney or Bullion Vault type systems, on the contrary, just that they are different to true allocated in the traditional sense.
“from the Perth Mint in Sydney, Australia”
I think there has been some confusion here as the Perth Mint does not have an office in Sydney, it is based entirely in Perth. I note that at the bottom of the second part of the article the link to the Perth Mint has one of our Perth Mint Certificate dealers who is based in Sydney, so that might account for it.
“there is precious little on the mints' website indicating how rigorously the allocated accounts are audited, particularly the independent verification that the amount of bullion in storage matches the number of certificates issued. It appears that at least some holdings may be audited by a third party, but the mint never responded to a query as to the details”
The Mint's FAQ page says “Allocated precious metal holders may inspect or collect their deposits at The Perth Mint … a third party nominated by you will be permitted to audit your deposit on presentation of an acceptable instruction from you to the Client Relations Executive of the Perth Mint Depository. The unsegregated nature of unallocated deposits, which are backed by the working inventory of the Mint, means it is not possible for an individual to audit them. Unallocated investors will need to rely on the Mint's audited Annual Reports, which are signed off by the State Auditor-General to ensure compliance with the Financial Administration & Audit Act 1985 and the Gold Corporation Act 1987”
Now on looking at our website and annual report, I note that there is no mention of who the State Auditor-General gets to do our audits, which is a bit remiss of us. One can be left with the impression that the Auditor-General’s Department does it, which I would concede is not as strong as an audit by a party independent of the Government. For the record, both our internal and external auditors are independent “big 4” audit firms. In this sense we are therefore no different to GoldMoney and Bullion Vault. In fact, having the State Auditor General appoint an independent auditor adds another layer of control, as the auditor’s work is then reviewed by the State Auditor General.
“the Western Australian government has a law already on the books that allows for all gold to be confiscated”
It is a Federal law, not state. To be balanced I think the article should also have mentioned that this applies to any other storage service as most countries have this risk, whether a law exists in a suspended state as in Australia or a new law needs to be enacted.
“For one thing, you cannot take delivery of your gold without first converting to an allocated account and paying additional fees”
These “additional fees” are simply fabrication and delivery costs, the same that you would pay if you bought allocated in the first place.
“The Perth Mint will not be liable or responsible for delivery delays due to causes beyond its control”
This text is a standard type of force majeure. I would point out that it refers to “delays”, not failure to do it at all. The nature of force majeure is that when the condition that brings it into play has finished, the obligations come back into existence – it is only referring to temporary events. For comparison, note the following similar clauses in the GoldMoney user agreement:
Net-Gold shall not be responsible for errors, negligence or inability to execute orders, nor shall Net-Gold be responsible for any delays in the transmission, delivery or execution of the User's order due to breakdown or failure of transmission or communication facilities, or to any other cause or causes beyond Net-Gold's reasonable control or anticipation including (without limitation) volatile markets or trading disruptions.
Whilst GoldMoney makes its best efforts to prevent unauthorised or fraudulent use of its system, GoldMoney disclaims itself from all liability for loss or damage, of whatever nature, caused as a result of the unauthorised or fraudulent use of a User's Holding number and Passphrase to the fullest extent permitted by law but excluding unauthorised or fraudulent use by GoldMoney and Net-Gold
GoldMoney shall be relieved from its obligations under this Agreement if and to the extent that it is unable to carry out all or any of its obligations hereunder owing to: i. Wars, civil commotion, vis major, act of God, strikes, riots, lockouts, governmental controls or restrictions, non-availability of any equipment or telecommunications or computer systems or any other causes beyond the reasonable control of GoldMoney
I think if one digs into any of the other storage services they will find similar force majeure clauses. This is standard business practice and is not at all sinister. I don't think people should interpret these as the Mint, GoldMoney or others as trying to get out of their obligations permanently.
Personally I think the article makes the differences between the Mint and GoldMoney and Bullion Vault too wide. The five part process described for GoldMoney also applies to the Mint:
1. The Mint is regulated and supervised just as much if not more than private companies. We have to comply with the same laws that apply to private companies plus the additional requirements of being part of a Government.
2. All bullion we hold is LBMA standard and/or internationally accepted and in the case of work in progress, we can easily make it into LBMA standard.
3. We store it ourselves, so there are fewer counterparties involved and to argue with in the event of any problem.
4. All our metal (unallocated and allocated) is insured by Lloyds, in addition to being guaranteed by the West Australian government.
5. Our accounts are audited by big 4 firms, the audit including verification of physical stocktakes and corresponding unallocated and allocated liabilities.
Nothwithstanding the above, I think the article is worth reading and should be reference material for first time gold buyers, as long as it says nice things about the Perth Mint of course :)
On thing I really like about the article is the way he distinguishes between physical and paper. His position is that if you don’t hold the physical yourself, you have a counterparty exposure, period. It is a position I hold but have seen very few, if any, make this point. Reading stuff on the internet gives me the feeling that a lot of people seem to think that because allocated is involved in whatever they are buying that somehow it is magically super safe!
The article then comprehensively discusses all the various paper options in a fairly balanced way (unusual these days). However, there are a few inaccuracies in his treatment of the Perth Mint which I discuss below. I have emailed James with the comments below and he was happy for me to publish them here and he will review/respond. The sections quoted in italics are from the article.
I also think the article could breakdown the paper options in a bit more detail. My view is that the risk hierarcy of paper gold products would be (there would be sub risks within the categories depending on the associated legals and trustworthyness of the provider of the service/facility):
Segregated Allocated - physically segregated specific coins and bars (including numbers) in your name.
Unsegregated Allocated - physically segregated gold (usually in bar form) in the name of the storage service provider where title resides with the holders as a group but no one bit of gold is exclusively identified as owned by a specific holder. Examples would be GoldMoney, BullionVault, Central Fund of Canada. ETFs can be included if you believe they have the gold, although considering the lack of accountability in the legals of some they may not qualify for this category from a risk point of view).
Unsegregated Physical Backed - an unsecured claim on a provider where the claim is backed 100% by physical in various forms. This is the strict definition of the Mint's unallocated. No different to unsegregated allocated except that title to the gold does not directly reside with the holders. Has to be ranked below the one above because the lack of direct title means you are relying on no other problems in the provider's balance sheet, even if they have 100% gold. In this sense you have true counterparty exposure as commonly understood. In retrospect, the Mint should never have used "unallocated" as this is commonly understood as defined below, which is not what we do.
Unallocated Fully Hedged - an unsecured claim on a provider where the claim is fully hedged by one or all of physical gold, futures, options etc. You are relying on this ability to hedge this properly - physical gold 1:1 is a perfect hedge, anything else is less perfect as it may not be able to be timed exactly with actual liquidations.
Unallocated Unhedged - an unsecured claim on a provider where the provider may or may not hedge the exposure, eg just hold your cash if they think the price is going down, hedge it if they think it is going up, they keep all the profits, if they make losses you are relying on the strength of their balance sheet.
Anyway, my comments to the article are:
“An allocated account is very different. In an allocated account the bullion must exist, and the amount you purchase is stored in your name. You hold actual title to your precious metals. The dealer in this case is guaranteeing that it has the same amount of assets in bullion as there are claims against those assets.”
I would pick a technical detail with this statement about the dealer holding the “same amount of assets”. This is not the strict definition of allocated, which is specific bars or coins in your name. In its most common form, this means you have specific bar numbers allocated to you. This is different to what he then leads in to discuss regarding GoldMoney etc. In fact, allocated at the Mint (or another other depository, eg Delaware Depository) would have to be safer than GoldMoney type systems because clients have title to specific bars or coins, not an “undivided interest in” allocated bars (from GoldMoney’s user agreement). Being undivided, one could argue that GoldMoney is really an unallocated allocated system! I would suggest that for completeness and accuracy true allocated should be separated from “undivided interest in allocated” systems. This is not to say that I think there is any problem with the GoldMoney or Bullion Vault type systems, on the contrary, just that they are different to true allocated in the traditional sense.
“from the Perth Mint in Sydney, Australia”
I think there has been some confusion here as the Perth Mint does not have an office in Sydney, it is based entirely in Perth. I note that at the bottom of the second part of the article the link to the Perth Mint has one of our Perth Mint Certificate dealers who is based in Sydney, so that might account for it.
“there is precious little on the mints' website indicating how rigorously the allocated accounts are audited, particularly the independent verification that the amount of bullion in storage matches the number of certificates issued. It appears that at least some holdings may be audited by a third party, but the mint never responded to a query as to the details”
The Mint's FAQ page says “Allocated precious metal holders may inspect or collect their deposits at The Perth Mint … a third party nominated by you will be permitted to audit your deposit on presentation of an acceptable instruction from you to the Client Relations Executive of the Perth Mint Depository. The unsegregated nature of unallocated deposits, which are backed by the working inventory of the Mint, means it is not possible for an individual to audit them. Unallocated investors will need to rely on the Mint's audited Annual Reports, which are signed off by the State Auditor-General to ensure compliance with the Financial Administration & Audit Act 1985 and the Gold Corporation Act 1987”
Now on looking at our website and annual report, I note that there is no mention of who the State Auditor-General gets to do our audits, which is a bit remiss of us. One can be left with the impression that the Auditor-General’s Department does it, which I would concede is not as strong as an audit by a party independent of the Government. For the record, both our internal and external auditors are independent “big 4” audit firms. In this sense we are therefore no different to GoldMoney and Bullion Vault. In fact, having the State Auditor General appoint an independent auditor adds another layer of control, as the auditor’s work is then reviewed by the State Auditor General.
“the Western Australian government has a law already on the books that allows for all gold to be confiscated”
It is a Federal law, not state. To be balanced I think the article should also have mentioned that this applies to any other storage service as most countries have this risk, whether a law exists in a suspended state as in Australia or a new law needs to be enacted.
“For one thing, you cannot take delivery of your gold without first converting to an allocated account and paying additional fees”
These “additional fees” are simply fabrication and delivery costs, the same that you would pay if you bought allocated in the first place.
“The Perth Mint will not be liable or responsible for delivery delays due to causes beyond its control”
This text is a standard type of force majeure. I would point out that it refers to “delays”, not failure to do it at all. The nature of force majeure is that when the condition that brings it into play has finished, the obligations come back into existence – it is only referring to temporary events. For comparison, note the following similar clauses in the GoldMoney user agreement:
Net-Gold shall not be responsible for errors, negligence or inability to execute orders, nor shall Net-Gold be responsible for any delays in the transmission, delivery or execution of the User's order due to breakdown or failure of transmission or communication facilities, or to any other cause or causes beyond Net-Gold's reasonable control or anticipation including (without limitation) volatile markets or trading disruptions.
Whilst GoldMoney makes its best efforts to prevent unauthorised or fraudulent use of its system, GoldMoney disclaims itself from all liability for loss or damage, of whatever nature, caused as a result of the unauthorised or fraudulent use of a User's Holding number and Passphrase to the fullest extent permitted by law but excluding unauthorised or fraudulent use by GoldMoney and Net-Gold
GoldMoney shall be relieved from its obligations under this Agreement if and to the extent that it is unable to carry out all or any of its obligations hereunder owing to: i. Wars, civil commotion, vis major, act of God, strikes, riots, lockouts, governmental controls or restrictions, non-availability of any equipment or telecommunications or computer systems or any other causes beyond the reasonable control of GoldMoney
I think if one digs into any of the other storage services they will find similar force majeure clauses. This is standard business practice and is not at all sinister. I don't think people should interpret these as the Mint, GoldMoney or others as trying to get out of their obligations permanently.
Personally I think the article makes the differences between the Mint and GoldMoney and Bullion Vault too wide. The five part process described for GoldMoney also applies to the Mint:
1. The Mint is regulated and supervised just as much if not more than private companies. We have to comply with the same laws that apply to private companies plus the additional requirements of being part of a Government.
2. All bullion we hold is LBMA standard and/or internationally accepted and in the case of work in progress, we can easily make it into LBMA standard.
3. We store it ourselves, so there are fewer counterparties involved and to argue with in the event of any problem.
4. All our metal (unallocated and allocated) is insured by Lloyds, in addition to being guaranteed by the West Australian government.
5. Our accounts are audited by big 4 firms, the audit including verification of physical stocktakes and corresponding unallocated and allocated liabilities.
Nothwithstanding the above, I think the article is worth reading and should be reference material for first time gold buyers, as long as it says nice things about the Perth Mint of course :)
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