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Misconceptions about gold ownership

How we own gold is a function of why we own it. We may buy gold as an ornament, as a speculation or as insurance against the depreciating purchasing power of crisis insurance, currencies and other assets.

For the speculator who needs exposure to the gold price, holding gold in an exchange traded fund (ETF) is a cost-effective way to receive a bid price in real time when exchanges are open. However, gold ETFs are leveraged or geared and may not own sufficient physical gold to cover their sales liabilities. In a crisis, owners of ETFs may find themselves an unsecured creditor to a counterparty risk.

Investors who doubt the solvency of the banking system, which was severely tested in the financial crash of 2009, hold gold bullion in vaulted secure storage. London, Switzerland and Singapore are the three most popular. Physical gold may also be held by joining other investors in buying shares in a trust company such as Sprott Inc. This trust is regulated and audited to ensure that the gold held for shareholders always matches sales liabilities.

Some banks and government refiners, like the Perth Mint in Australia, offer custody and storage of physical gold in certified allocated and unallocated form. Investors need to be aware of the risk of owning gold in an 'unallocated' form. In this case, the custodian does not store gold belonging to you. An investor holding unallocated gold has a claim against a deposit receipt, not physical gold, leaving himself as an unsecured creditor.

The risk of holding unallocated gold lies in the fact that the custodian uses it for production, and assets do not match sales liabilities. Although a pool of investors have certified deposit receipts, the custodian does not allocate gold to specific liabilities. As it is being used in daily production, the producer ensures the ability to deliver physical gold with a third party. Should the insurance company be unable to cover claims, the investor will not be able to redeem the deposit receipt. This was the case in 2009, when AIG, the largest insurance company in the world, filed for bankruptcy.

In contrast, 'allocated' gold is a claim on a specific amount of gold that is held in storage and segregated from refining and production. The fact that it is allocated to investors off balance sheet means they will receive delivery in case of bankruptcy. Regular audit guarantees that sufficient gold is segregated by the custodian to match their liabilities and that in a crisis every investor will receive delivery of physical gold bullion. Investors should only buy bullion from an accredited refiner which is assayed as 'London good delivery', indicating that it is 99.5% pure. To maintain integrity, gold should only move between accredited bullion dealer vaults.

Investors should refrain from being seduced by the low costs of ownership of 'unallocated' gold. This defeats the purpose of owning gold as an insurance against market risk and devaluation.