The principal contention of this article is that most investors who think they own gold or silver bullion really don’t. Most precious metals investments – including many touted as physical – are nothing more than paper promises. Townsend discusses the details of counterparty risk in precious metals investing, and evaluates ‘paper’ vs. ‘physical’ bullion investments, as well as allocated vs. unallocated bullion accounts. The executive summary:
- The rationale most commonly cited for investing in precious metals is wealth preservation: precious metals provide a durable store of value that eliminates counterparty risk inherent to other investments;
- Counterparty risk is only eliminated if the investor actually owns the precious metals he invests in free and clear of any encumbrances;
- Most precious metals investments, including many touted as ‘physical gold’ do not actually convey legal ownership of precious metals to the investor. As a result, the elimination of counterparty risk rationale for the investment is defeated!
- You do not own gold unless you have taken delivery of coins or bars personally or have received legally binding documentation showing you to be the legal owner of specific coins or bars (identified by bar serial numbers) stored with a bullion bank in an allocated account that is allocated in your name;
- The physical gold vs. paper gold debate is revisited with an emphasis on counterparty risk. It turns out there are many layers of both ‘physical’ gold and ‘paper’ gold and these are explored;
- Critics of ‘paper gold’ ETFs are sometimes guilty of scaring investors away from the ‘paper’ aspect of the ETFs, only to go on to sell the investor a competing ‘physical gold’ investment that is really nothing more than another form of paper promise;
- The LBMA chain of custody system (and other similar systems worldwide) provides a way to own physical bullion stored in a commercial vault without the need to re-assay the bars each time the bullion changes hands.