A look at unallocated and allocated gold...
THE UNIVERSITY OF TEXAS INVESTMENT MANAGEMENT CO. (UTIMCO) grabbed the attention of the gold world this week when it announced it was switching its gold investments to physically allocated gold bullion, writes Julian Phillips at GoldForecaster.com.
UTIMCO has taken delivery of around 20 tonnes of gold in the form of 6,643 Gold Bars, worth $987 million at Monday's prices. It is now stored in a bank warehouse in New York.
This event was treated as remarkable in the United States. In Europe and nations east of Europe, the concept of holding gold bullion is more than normal, it is good sense. So in a nation that is used to investing in gold derivatives, why has a leading US investment fund turn to physical Gold Bullion registered in their name?
The Texas fund's $19.9 billion in assets rank it behind only Harvard University's endowment, making their action all the more important. The reason given was that the fund's managers sought to take delivery of bullion to protect against demand for the metal overwhelming supply.
In a nutshell, the advisor to the fund gave their reasons for Buying Gold in the first place – a reason we have highlighted persistently over time.
It was this: "Central banks are printing more money than they ever have, so what's the value of money in terms of purchases of goods and services. He said, "I look at gold as just another currency that they can't print any more of."
With that in mind it becomes obvious that gold held in a derivative form is not really holding gold at all. The Texas Fund said holding cash wasn't a better choice because the rate of inflation exceeds money-market rates by 2.5% to 3%, eroding the value of cash.
This reason, and the reason to hold gold in the name of the beneficial owner directly, raises all sorts of questions.
"What levels of security of gold ownership do investors really have?" is perhaps the most important question for a gold investor.
Clearly, investors' trust in the ability of banking institutions and derivative markets to access the gold that their gold instruments imply is diminishing. In addition, the reality that there is far less gold available than the sum total of derivatives imply that this consideration is becoming a market factor.
Overall the concept of the profit motive in gold markets is giving way to the concept of preserving wealth with physical gold bullion, a concept almost foreign to US investors until now.
Holding an investment related to the price of gold is not owning gold. For instance, an option to buy or sell gold is a financial instrument that does not involve gold itself, unless the option is exercised. It is only the right to buy or sell gold.
A small percentage of the value of the gold where the investor has the 'right' to buy or sell gold is paid to the option grantor. Usually as the date of the expiry of the option draws near, the option holder either walks away from the option so as not to take a loss, or exercises the right and immediately buys or sells the underlying gold to close the position. In that case no physical gold is involved not is physical gold owned until – and indeed unless – delivery is taken.
In the case of a Gold Futures contract the investor puts down a deposit – around 10% or more – and buys or sells gold at a future date, paying the interest due or receiving it during the period of the transaction. A matching transaction, to close the position, is taken at or near the date of the expiry of the contract.
Hence 95% of such contracts are financial contracts only and don't involve physical gold at all.
Indeed, if the intention is to take or give delivery of gold, under COMEX rules, the counterparty must be informed and agree to be the counterparty in a physical gold transaction.
As COMEX itself will confirm, only 5% of such transactions will involve physical gold. So COMEX is not really the place to Buy Gold. As the Texas fund said, "the fund's managers sought to take delivery of bullion to protect against demand for the metal overwhelming supply."
They explain their fear of COMEX as follows: "Open interest in Gold Futures and options traded on the COMEX typically exceeds supplies held in its warehouses. If the holders of just 5% of those contracts opted to take delivery of the metal, there wouldn't be enough to cover the demand."
Few investors take physical delivery of bullion. As of April 14, 2,860 contracts this month, about 0.5% of total open interest, had been converted to metal, exchange data show.
The bulk of the World Gold Council-sponsored gold Exchange Traded Fund holds 'unallocated' gold, where the Custodian – i.e. the bank that holds the gold – does not 'allocate' specific gold bars to the individual client, but rather, states that from its stockpile of gold, the Fund is a part owner.
Against this the gold Exchange Traded Fund issues shares to investors with each share representing a specific amount of gold. It is generally accepted that the gold holdings of the fund equal the total number of shares issued.
As the shares are bought and sold, so the fund buys and sells the gold equivalent. The investor therefore does not own actual gold, the fund does. Most investors trust the integrity of the Fund managers and the bank acting as Custodian to ensure that there is gold to meet the shareholding.
Some funds may allow outsiders to lease the gold from them to add income to the fund but this adds the risk that the gold may not be returned by an outside party. Some investors feel that their bank's, current, unallocated gold holdings may not match its gold obligations and when push comes to shove. They fear, as does the Texas Fund, that there may be a shortfall and not all investors will be able to take delivery of their gold.
There are gold trusts where the gold is owned 'on behalf of investors'.
These can take one of two forms. They can hold gold in 'unallocated' form by the Trust, where leasing or leveraging is permitted, which does involve risk to their gold holdings. Like the Texas Fund feels, a shareholder in such Trusts may feel that the link to the actual underlying gold is insufficient.
We are aware of a Trust that satisfies its clients that the gold is held for them and they can check on it every day, for the Custodian does provide a reconciliation on its gold holdings on a daily basis. Such a Trust comes with many more benefits.
Any individual that feels his home – or whatever storage facility he uses – is secure can hold his own gold without fear of losing it. Most Asian investors hold it this way.
And of course for small holdings, bank deposit boxes can be used. As this is private even from the bank housing the deposit, many feel this way is sufficient to give them the security they want.
Other gold investors just don't trust the government they are under and want to hold their gold bullion outside the country. The generally preferred location is Switzerland with its remarkable history that has protected individual investors even from their own government for centuries, even during wars.
Companies like BullionVault and GoldMoney offer direct physical ownership of gold held in Switzerland. BullionVault – which is backed by the World Gold Council as well as an investment fund whose only client is the highly successful Rothschild Investment Trust (RIT Capital Partners) – holds the gold in the client's name, and gives them an anonymous 'codename' allowing them to check on a daily basis, and via a freely published register, that their allocated gold is in the vault where it should be.
The direct benefit of this method is that the client knows his gold is there, unleveraged, un-leased and linked to him directly. Both BullionVault and the independent custody company its clients use are outside the banking system too. This is important, because banks rely on governments for their licenses. Hence, they will obey a government even at the expense of their clients. So a private vault, of good reputation, is far more secure that a bank vault in hard times, we believe.
The Texas Fund holds its gold in a US bank warehouse so that it feels secure in that ownership. Though it remains vulnerable to action by the bank or the US government, the Texas Fund, for the meantime, has direct ownership of its own gold.
Holding gold bullion in London is a route sometimes selected by a US investor, because he feels that he is then out of reach of his own government. Perhaps that may not always prove to be the case though.
Buy allocated gold bullion – and store it safely in either London, New York or Zurich – with BullionVault...