Thursday, April 22, 2010

Allocated Gold or Unallocated Gold – That is the Question

What is the difference between allocated and unallocated gold? Why should there BE a difference? And what benefits are there for the gold investor when it comes to the security of allocated and unallocated gold accounts?

Firstly let us look at how the allocated and unallocated system works.

Allocated Gold Account

An Allocated gold account means that the gold is owned outright by the investor or account holder. Usually this will be in a size comparative to the holding of the investor. It might be small bars and coins for a small investor but large 400 ounce gold bullion bars for a large investor. The account holder pays a storage and sometimes an insurance fee.

Most importantly the holdings are secured against the account holders name and the serial numbers or other identification is registered to that account holder. The account holder can redeem, or take out, the gold he has in their name at any time and have it shipped else where.

It should be noted that gold exchange traded funds do NOT include allocated gold.

Unallocated Gold Account
Unallocated gold accounts are an entirely different story. Here the account holder does not own specific physical gold but only a value 'backed' by gold kept in storage by the bank or company, such as GLD for example, who hold the gold 'in trust'.

This is the exchange traded funds at work. The gold is not secured to any gold account and there is no guarantee of ownership of any gold. In fact the LBMA description of unallocated gold disturbingly points out:

"Unallocated accounts. This is an account where specific bars are not set aside and the customer has a general entitlement to the metal. It is the most convenient, cheapest, and most commonly used method of holding metal. The units of these accounts are one fine ounce of gold and one ounce of silver based upon a .995 LGD (London Good Delivery) gold bar and a .999 fine LGD silver bar respectively."

It also states "The client is an unsecured creditor." Which is somewhat contradictory to the previous statement. Whereas the client who has an allocated gold account can point to some gold and say, "This is mine!" The unallocated gold account owner can only say they have lent money, at cost mind you since they have to pay for the privilege, to the institution who promise that those funds are backed by gold and the price is index-linked to gold. But the resemblance to owning gold stops there. You cannot redeem unallocated gold since you do not actually own any of the gold in the first place.

The institution may or may not have sufficient gold to cover the total value of all unallocated gold accounts and even if they do, they are also not bound to NOT use that gold elsewhere for another purpose, neither do they assume any responsibility for the safe deposit or storage done by a third party on their behalf.

This enters into the fractional system of using Paul to pay Peter. A common pastime of banks in general.

Our recommendation, if you want to have or own or hold actual gold, is to buy gold, and not a representation of it. Buy physical gold and have it stored. You can buy small bullion bars or large one depending on your own personal financial situation and one can buy on a regular basis to build up a gold store. But certainly we do not recommend you buy unallocated gold as, really, you are only buying a piece of paper that says your account is worth the same as the futures gold price. Not actually gold.

Monday, April 19, 2010

A Gold Ponzi of Mass Deception?

A Ponzi scheme one tends to associate with back street traders of dubious reputation and an unprofessional con man out for a quick buck.

But only recently Adrian Douglas from the Gold Anti Trust Association (GATA) confirmed in testimony to the U.S. Commodity Futures Trading Commission (CFTC) that the London Bullion Market Association is operating a massive fractional reserve gold market which he refers to as a Ponzi scheme.

This has also been confirmed by Jeffry Christian of the CPM Group who noted that the London "physical market" is actually trading a hundred times more paper gold than there is physical metal to back those trades.

One might wonder how the LBMA can sell gold bullion that they do not actually have in their vaults.

This is done through the allocated and non allocated account system.

In an allocated account, an investor will have specific bars of gold specifically assigned to him and when the gold bars are purchased the investor will be given the serial numbers. That investor has full title to that gold bullion and the dealer acts as a custodian, holding the gold on behalf of the client. The LMBA describes allocated accounts as"

"These accounts are opened when a customer requires metal to be physically segregated and needs a detailed list of weights and assays. The client has full title to the metal in the account, with the dealer holding it on the client's behalf as a custodian."

An allocated account is where the investor has on deposit with a financial institution specific bars of gold or silver that are segregated for him and he is given their serial numbers. This gold and silver can be audited and the customer can have confidence that his investment is safe insofar as it really exists, is being stored on his behalf, and he has title to it.

With an unallocated account, however, the situation is vastly different. The gold or silver is held by the bullion bank but not identified by serial number. So when a client buys unallocated gold they do not get allocated bars of gold. If, for example, two customers each buy 200 ounces of gold they could together be assigned one 400 ounce London Good Delivery (LGD) gold bar. So each client is not assigned a specific gold bar but a real bar is held 'on their behalf.'

The LBMA description of unallocated precious metal accounts states:

"Unallocated accounts. This is an account where specific bars are not set aside and the customer has a general entitlement to the metal. It is the most convenient, cheapest, and most commonly used method of holding metal. The units of these accounts are one fine ounce of gold and one ounce of silver based upon a .995 LGD (London Good Delivery) gold bar and a .999 fine LGD silver bar respectively."

One would think, therefore, that if 20,000 unallocated account holders collectively bought 200 tonnes of gold, there would naturally BE 200 tonnes of gold resting in the vaults.

However, The LMBA definition of unallocated also goes on to state:

"Transactions may be settled by credits or debits to the account while the balance represents the indebtedness between the two parties."

"Credit balances on the account do not entitle the creditor to specific bars of gold or silver, but are backed by the general stock of the bullion dealer with whom the account is held. The client is an unsecured creditor."

So, as Adrian Douglas of GATA correctly points out, "The balance on the account is a measure of "indebtedness between the two parties." In other words the account balance is an IOU for bullion. It is NOT really a "method of holding metal" as first described by the LBMA. No, the unallocated account is backed by the general stock of the bullion dealer -- and that may be, as Jeffrey Christian has confirmed, only one
physical ounce for every hundred ounces that have been sold in unallocated accounts."

Importantly, it also states that "The client is an unsecured creditor." If 10 tonnes of gold are bought for 10 clients with allocated accounts, those ten clients are secured, but if the accounts are unallocated, then they are unsecured and there is no guarantee whatsoever that there is gold to cover that clients holding. Otherwise why describe them as unsecured. This opens the door to operating a fractional-reserve basis and, while that might be acceptable for currency, it is certainly not acceptable for gold being held in trust for clients.

Unallocated accounts are not then, "the most convenient, cheapest, and most commonly used method of holding metal." Rather, they are an unsecured way of holding an IOU for gold or silver bullion. Just a paper promise.

Indeed, an unallocated account holder is really just lending money to the bank at a negative interest rate, as the customer is the one that is paying the fees for the privilege of lending the bank money. The only real connection between gold and the 'loan' is that the loans are index-linked to the price of gold bullion.

The message is then, there is nothing so secure as holding actual physical gold and if one has to have gold held for one, ensure it is an allocated account and have the attendant security that goes with that gold. You should also have the serial numbers of the bars you own so you do know you indeed actually own some gold.

Wednesday, April 14, 2010

Counterfeit gold, how real is it

Faking or counterfeiting gold has been a popular pastime for criminals out to make a fast buck for hundreds of years. From using 'fools gold' to steel and lead coated gold to the now modern sophisticated pastime of tungsten coated gold bars.

Alarming as this sounds, coating other material in gold is, in itself, not a criminal activity. Gold plated copper in jewellery has been common through the ages and made owning gold affordable to many who were not in a position to buy solid gold jewelry and the coating tungsten in gold is definitely not new either. There are companies around that do this on a regular basis including Chinatungsten which has been in operation since 1997 and is one of the biggest produces of tungsten jewelry in China

What is of concern however is the possible deception of LDMA gold bars being really tungsten coated in a layer of gold as has been discovered recently.

When it comes to faking gold bars tungsten is the ideal metal. With a density and weight fractionally close to gold it is difficult, if not impossible to tell the difference between a genuine gold bar and a tungsten coated bar.

When the news of the tungsten gold bars surfaced in Hong Kong it was first assumed they were manufactured there. After all China has the reputation of being the biggest knock-off capital of the world. However the amount of gold bars in question was allegedly between 5,600 and 5,700 – 400 or around 60 metric tonnes. Such a sizable amount would have to be organised by a well financed and resourceful organisation.

Within hours of this scam being identified, the Chinese officials had most of the perpetrators in custody and apparently uncovered the following:
Roughly 15 years ago - during the Clinton Administration [think Robert Rubin, Sir Alan Greenspan and Lawrence Summers] – between 1.3 and 1.5 million 400 oz tungsten blanks were allegedly manufactured by a very high-end, sophisticated refiner in the USA [more than 16 Thousand metric tonnes]. Subsequently, 640,000 of these tungsten blanks received their gold plating and WERE shipped to Ft. Knox and remain there to this day. I know folks who have copies of the original shipping docs with dates and exact weights of "tungsten" bars shipped to Ft. Knox."
Rob Kirby, Gold Seek

The balance of this 1.3 million – 1.5 million 400 oz tungsten cache was also plated and then allegedly "sold" into the international market. So the global market is literally "stuffed full of 400 oz tungsten coated bars".

Now, the two biggest gold exchange traded funds, StreetTracks and SPDR, both have their gold bars held by the LBMA Banks. When you consider there are well over a billion dollars in deposits with these two trusts, the GLD itself holds over 1117 metric tonnes of gold bullion than the central banks of China, Switzerland, Japan, Europe and India, then it becomes a big matter that so much of the gold is likely not really gold at all but tungsten with a coat of gold over it.

Why not make fake gold coins with tungsten some might ask. In fact just by weighing the coins you can tell the difference. As coins are circulated more, as distinct to a gold bar that will sit in a dusty bank vault for years on end, they are more likely to be detected. The credibility of gold bars lies more in the paper work and tracking of each individual gold bars number than handling. It also cost 50,000 dollars to manufacture a 400,000 dollar gold bar taking into account the cost of the gold and labor. Fake tungsten gold coins would be too expensive to manufacture each. Not only that gold coins have a lot of detail, ridges on the sides etc and there are many people out there than can detect fake coins so it is economically unviable to fake gold coins.

It is a good idea then to invest in real gold rather than paper gold and ensure that the gold you are investing in IS gold and not some counterfeit. Especially with the probably impending rise of the gold price.

Gold ETFs, the real McCoy or just paper in the wind?

Probably the biggest gold exchange traded fund is SPDR Gold Fund (GLD).
"ETF investors piled into shares of SPDR Gold Shares(GLD) to the tune of $828 million in March as currency concerns kept the metal attractive. A rise in the price of the metal helped push net assets under management up more than $1 billion, to a new high of $40.5 billion." The Street, April 2010.

The SPDR Gold Traded Exchange Fund was started just seven months after Rothschild exited the gold market in 2004.
"LONDON, April 14, 2004 (Reuters) - NM Rothschild & Sons Ltd., the London-based unit of investment bank Rothschild [ROT.UL], will withdraw from trading commodities, including gold, in London as it reviews its operations, it said on Wednesday."

Why would one of the most active traders in gold suddenly decide to withdraw from the gold market one wonders. Coincidence or not, a study of the prospectus for GLD shows some alarming statements.

In the GLD prospectus on page 11 it states:
"Gold bars allocated to the Trust in connection with the creation of a Basket may not meet the London Good Delivery Standards and, if a Basket is issued against such gold, the Trust may suffer a loss. Neither the Trustee nor the Custodian independently confirms the fineness of the gold bars allocated to the Trust in connection with the creation of a Basket. The gold bars allocated to the Trust by the Custodian may be different from the reported fineness or weight required by the LBMA’s standards for gold bars delivered in settlement of a gold trade, or the London Good Delivery Standards, the standards required by the Trust. If the Trustee nevertheless issues a Basket against such gold, and if the Custodian fails to satisfy its obligation to credit the Trust the amount of any deficiency, the Trust may suffer a loss."

This means in effect that gold bars held in trust are not guaranteed to actually BE genuine gold bars but could easily be something else instead. Later down the page it states.

"Because neither the Trustee nor the Custodian oversees or monitors the activities of subcustodians who may temporarily hold the Trust's gold bars until transported to the Custodian's London vault, failure by the subcustodians to exercise due care in the safekeeping of the Trust's gold bars could result in a loss to the Trust."

So no responsibility is taken for the gold bars held by LBMA Banks on behalf of the trust. In view of the latest exposure of some LBMA gold bars actually being counterfeit and really just tungsten bars coated in gold this could be of some concern to large holders of GLD certificates.

Detecting a high-quality fake tungsten gold bar is not easy. The only way to do so is to drill a hole through the bar and see what comes out. A genuine gold bar and a bar filled with tungsten is going to weigh virtually the same since tungsten weighs within a fraction the same as a gold. The density is very similar also so those two principle methods of checking gold bars are practically useless. To properly test a gold bar would likely require significant and material alterations to the bar being tested and this would negatively affect the marketability even when its hallmark veracity is vindicated.

During a recent Commodity Future Trading Commission hearing in Washington DC, Jeffry Christian of the CPM Group, testified that the LBMA Banks actually have about a hundred times more gold deposits that actual gold bullion. This means that gold is now being treated by the LBMA banks as a fractional deposit.

Alarm bells ring when you consider that most of the gold held 'in trust' by the Gold EFT, GLD is held in LBMA Banks. So of the lesser amount of gold held against the actual deposits, how much of that is not really gold at all?

If and when the proverbial hits the fan it might be better to have removed any gold deposits while they still have some value.

Investing in solid gold, rather than paper gold is probably a wiser move when more people realize there is likely much less gold available than was previously thought and the price of gold consequently shoots up through the ceiling as a result.