Today In Silver

This is a comment on a comment by Bron Suchecki who is commenting on a commentary about gold and silver storage options. Confused? You should read the original pieces by Mr. Suchecki and Mr. MacFarlane as they both contain some very important points. I’ll focus on a few sections of Mr. Suchecki’s work to which I will add my two bits as his is the more clear and concise of the two.

From Mr. Suchecki:

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):

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.

Segregated Allocated - physically segregated specific coins and bars (including numbers) in your name.

I would actually recommend looking at this in a slightly different hierarchy while maintaining some of the important differentiations introduced in the referenced commentaries. One of my main problems is the use of the term “segregated” which actually has dual meanings in the bullion storage business. “Segregated” can mean either allocated or physically separate depending on where you are. For example in London, allocated and segregated are interchangeable so the statement “segregated allocated” is redundant. In New York, however, there is a distinction between segregated and unsegregated accounts (both of which can be allocated) as well as allocated and unallocated accounts (either of which may be pools or unsegregated).

Bear with me, I’ll try to mesh all of this together into something that makes sense (in order from safest to most risky):

(1) True Allocated Storage — Specific bars and rounds held in your own name where the vault facility is merely providing a storage service and you have full legal title to the metal. Often the storage fee includes insurance. Other than that, you can think about this like any other type of storage.

• Segregated — Bars and rounds are stored in a physically separate if not physically secure manner away from the bullion of other storage customers. This typically costs extra but is often required under some custodial arrangements or for improved audit control of inventory. This is the standard for London storage due to the different weight and fineness of good delivery bars. Both the large ETFs, SLV and GLD, hold their metal in this manner but you as shareholder of the ETF are only a beneficiary of the ETF (see below).

(2) Pool Allocated — You have title to a divisible interest in a pool of bullion stored in a specific vault although no specific bars or rounds are set aside in a physically segregated manner for each customer. Many storage accounts that are labeled “segregated” or “allocated” may actually work this way (see below). This is only possible if the pool of bullion is homogenous (specific rounds or bars with the same weight and characteristics) and equally divisible. Examples include a specific year of bullion coin or specific weights of retail bullion bars (such as some 100 oz. silver bars and kilo gold bars). Pool allocated accounts aren’t possible with good delivery bars since the different weight and fineness of each bar means that it is not fungible.

• Unsegregated — Bars and rounds that you own are stored in a vault along with the bullion of other storage customers. You legally have title to individual bars and rounds, but if you purchased them from a dealer that provides storage (a fairly common arrangement in the U.S.), then for practical purposes you may have a pool allocated account. I suspect this is actually how the Perth Mint works as well for some of its product. For example, if you order 50 gold 2009 Kangaroos from the Mint for allocated storage, I don’t think the Mint will physically take the 50 Kangaroos, put them in a box or tubes with your client number on it and store them in a physically separate location. Instead the Mint will add 50 Kangaroos to the allocated vault shelves and put your client number along with quantity on the allocation list. If you take delivery, any 50 Kangaroos dated 2009 will do. Mr. Suchecki can hopefully clarify this point.
• From a legal or risk standpoint there is only a minor difference between allocated (segregated) and pool allocated (unsegregated) accounts. Unless a very strict custodial arrangement is required or the account contains good delivery bars, the pool allocated approach can sometimes be more appropriate for efficiency, cost or insurance considerations.

(3) Trust Beneficiary, Bailment, Contractual — This is a typical format for metal ETFs but surprisingly most online gold accounts use this format as well despite their owners’ strenuous attempts to declare an alternate reality. In this format the investor actually holds a beneficial interest in a trust, custodial interest specified by contract or a bailment balance that in turn represents fractional ownership of an underlying metal pool. The rights and obligations of the investor and issuer are specified in the trust or custodial agreement. The trustee or custodian itself may hold the metal in any of the formats outlined here including allocated, pool allocated or unallocated. In the case of the gold and silver ETFs, SLV and GLD, the trusts hold the metal in LBMA allocated form. Importantly, the storage is in the name of the trust or custodian, not the individual bullion customer or shareholder.

(4) Unallocated — You do not have legal title to any bullion at all but merely hold a claim against the issuer of the account (typically the storage facility). If there is physical bullion backing, title to the metal is held by the storage facility or issuing counterparty. Regardless of backing, you are merely a creditor. By definition, unallocated accounts are always unsegregated as well.

• Physical-backed — Kitco, Perth Mint, LBMA and many others offer an account where each unallocated ounce is supposed to be backed by an unencumbered ounce of physical metal owned by the storage facility or account issuer. Apparently just to confuse things, an unallocated account is sometimes also called a pool account (such as the Kitco pool account). This type of pool account (unlike an allocated account) does not confer on the account holder legal title to any bullion. Depending on local bankruptcy or insolvency laws and the specifics of each storage contract, the unallocated account holder may or may not have a secured interest in the unallocated metal (in the case of LBMA the interest is unsecured). Under some circumstances, a secured interest entitles a bullion account holder to a priority distribution of assets before unsecured creditors are paid during a liquidation. If you are going to be a creditor, you want to be secured instead of unsecured. Moreover, although the distinction is not adequately covered on the Internet, it is incumbent on you as an unallocated account holder to understand your creditor status and well as the financial viability of the counterparty that has issued your account. Here is where an entity like the Perth Mint with its long-standing governance and state government backing probably makes a very big difference. Regardless, with a physical-backed unallocated account you are generally entitled to take delivery of bullion within stated parameters assuming the account issuer is capable of delivering fabricated bullion product to you (here again it matters if the issuer is an active mint).
• Not physical-backed — Typically this type of account is offered by banks, brokers and insurance companies. This is a general unsecured claim and the return of your initial investment, much less gains, is dependent on the solvency of the entity issuing you the unallocated claim. You generally have no right to receive physical metal; this is what people are really talking about when they mention “paper metal”. At the same time, the amount of investor funds, especially in the retail sector, that unallocated accounts of this type attract is way overblown by the average gold and silver commentator especially when he or she is hyperventilating about the bullion price suppression conspiracy. Needless to say, there is absolutely no reason to put a single dollar into this type of account and anybody doing so deserves to lose everything as punishment for stupidity.

The last point I will make before moving on is that any “lack of accountability in the legals”  of the metal ETFs — that Mr. Suchecki alleges might exist — is not a consequence of the format in which the metal is stored, which is a standard allocated LBMA account (the same allocated LBMA account that you or I could get if we had enough money), but rather the format of intermediary ownership specified in the ETF’s trust agreement. A proper assessment of the particular ETF’s risk in comparison to directly holding an allocated LBMA account should therefore be  made on the basis of legal flaws in the trust agreement, not the storage arrangement per se. Although there have been attempts to point out precisely such flaws in the past by people like James Turk and others of lesser repute, these have been nothing more than futile attempts.

Now for some more from Mr. Suchecki:

“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.

Bingo!!! I’ll take it even a step further and say that GoldMoney, BullionVault, etc. are not even a direct form of metal ownership such as pool allocated accounts. The issue isn’t really “undivided interest” or “unallocated allocated” but rather that such programs are actually beneficiary trust forms or other intermediary business relationships that merely add an additional custodial layer on top of the underlying form of storage.

In the case of the SLV and GLD ETFs, we have ETF shareholders owning an interest in a beneficiary trust that holds gold and silver in LBMA allocated format. In the case of GoldMoney, BullionVault, etc., we have agreements and bailments respectively but the underlying storage is essentially the same LBMA allocated format. We can argue about the audit provisions and level of fiduciary responsibility of each of these programs but at the end of the day LBMA allocated is LBMA allocated regardless of the number of times the intermediate forms are audited. Bottom line, if you want the lowest level of storage risk, you don’t hold bullion via the ETF trust, GoldMoney agreement or BullionVault bailment but rather directly through the LBMA allocated storage account. Otherwise, you are making a compromise between risk and convenience that is more-or-less equal between the alternatives. Don’t let anyone tell you different, least of all James Turk or Adrian Ash.

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