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Take care when buying from a bank

Unallocated gold

As you set out to buy gold the first thing you need to know is that 95% of the world's gold traders will automatically sell you the wrong type.

Unallocated gold is the most widely traded form of gold in the world. It hides a way of advantaging the provider - usually a bank - by subjecting buyers to a risk they will frequently remain unaware of until it is too late. The widely quoted 'spot price' refers to this unallocated gold, and this is how it works:-

  1. When a bank sells you unallocated gold on the spot market you become a creditor - i.e. the bank owes you gold which you do not own. The bank is taking advantage of the fact that you are not quite sure what to do with any gold you buy, and it feels logical - to most gold buyers - to put the gold safely in the bank. When you do this you become, in law, a depositor of gold. Most people now relax in the belief that they own gold completely securely, and they do not pay the little extra - above the spot - to have their trade formally 'allocated'.

  2. A bank is required by its regulator to hold a proportion of its liabilities as certain types of assets capable of being turned into cash quickly during times of crisis. It is a liquid reserve and it's there to protect the bank from a common type of problem - a liquidity crisis - which occurs when a bank has short term deposits, long term loans, and insufficient cash to meet the immediate demand for withdrawals. Physical gold bars are accepted as a very good form of liquidity reserve because they can be turned quickly into cash.

  3. If a bank has physical possession of some gold which it owes you as its creditor the bank itself is the current owner of the gold. While this gold remains unallocated to you the regulator considers it part of a bank's liquid reserve. This makes unallocated gold an attractive way for the bank to maintain its regulated liquidity, because you have paid for your gold, and the bank is free to use your money, while it is also able to add your unallocated gold holding to its own reserve.

  4. So your unallocated gold would be ditched if the bank were in need of cash. It has no choice in the matter because liquid reserves are there to be sold at short notice to protect the bank's general creditors - all of whom, including you, must receive a proportionate share of whatever is raised from the sale of assets should the crisis deepen and the bank become insolvent.

  5. If that did happen you would be in a bad position. The bank's small gold reserve would be diluted by non-performing bond portfolios and other assets which don't sell well in a crisis. The last line of defence for bank depositors is deposit protection, which is a state underwritten mainstay of banking confidence in the West. But it does not apply on bullion debts like yours. Deposit protection is there as a confidence-builder for the national currency only, which means unallocated gold actually offers less protection from bank failure than a cash deposit. So having been the provider of the bank's liquidity reserve you will then be in the minority of those offered no protection by the state's guarantee.

  6. So it is important not to be impressed by unallocated gold, or by it being physically stored in a bank's vault, or by it being checked daily by bank regulators. Regulators are checking it to make sure the bank maintains a liquid reserve, and they are not interested in your entitlement as a bullion creditor.

Allocated gold is different because you become the outright owner of gold and you are no longer a creditor. Your allocated gold is your property and it cannot be used as the bank's reserve, so with allocated gold you get proper protection from systemic failure.

Unfortunately with allocated gold your money does the bank no good. And since modern banks reckon to earn 20% each year on capital employed, their loss of use of your allocated gold is disappointing for them. This is why banks usually charge nothing for unallocated storage and at least 1.5% per annum for allocated storage, with the result that professionals in the bullion market reckon that less than 1% of gold traded within financial markets is allocated.

This is how the huge majority of the world's owners of bank held gold are - probably unwittingly - storing their personal reserve in a way which fails to meet the most common objective of gold buyers.

Illustrating the market dominance of 'unallocated' gold

Unlike banks some suppliers buy real physical bars. BullionVault is one, and it buys its gold from a major international bullion dealer, which also deals in volume with counterparties all over the world. BullionVault insists on physical delivery of bars into ViaMat vaults, which enables BullionVault users to become the outright owners of the gold they buy. It costs an extra dollar and a half an ounce.

As its customers buy gold BullionVault re-loads its inventory with physical purchases. So its 'Bar List' gradually grows, with batches of bars delivered sometimes a few days apart, and sometimes a few weeks. The bars were originally manufactured by a refiner, and stamped there with their unique bar numbers. They are the normal 'Good Delivery' size of 400 oz, which is the standard specification used to settle physical bullion market deals.

You can check out the actual BullionVault ViaMat list if you want because it is published daily on the internet but the table below shows the important data.

Bar No Location Delivery
5812 Zurich 18-Jan-06
5813 Zurich 18-Jan-06
5814 Zurich 18-Jan-06
5815 Zurich 18-Jan-06
5816 Zurich 09-Feb-06
5817 Zurich 09-Feb-06
5818 Zurich 09-Feb-06
5819 Zurich 09-Feb-06
5820 Zurich 14-Feb-06
5821 Zurich 14-Feb-06
5822 Zurich 14-Feb-06
5738 Zurich 09-Mar-06
5739 Zurich 09-Mar-06
5740 Zurich 09-Mar-06
5741 Zurich 10-Apr-06
5742 Zurich 10-Apr-06
5743 Zurich 10-Apr-06
NS 1226 London 09-Jan-06
NS 1227 London 09-Jan-06
NS 1228 London 09-Jan-06
NS 1229 London 03-Feb-06
NS 1230 London 03-Feb-06
NS 1231 London 03-Feb-06
NS 1232 London 21-Feb-06
NS 1233 London 21-Feb-06
NS 1234 London 21-Feb-06
NS 1235 London 14-Mar-06
NS 1236 London 14-Mar-06
NS 1237 London 14-Mar-06
NS 1238 London 25-Apr-06
NS 1239 London 25-Apr-06
NS 1240 London 25-Apr-06

See how over the four weeks from 18-Jan 2006 to 14-Feb 2006, with the delivery of three separate purchases, the bar numbers delivered to BullionVault in Zurich are sequential. Then over the four and a half weeks from 19-Mar-06 to 10-Apr-06 they were sequential again, for 2 more deliveries. Then in London notice that all five physical deliveries between 09-Jan-06 and 25-Apr-06 are sequential too.

What seems like a logical conclusion (and BullionVault's main market dealers have confirmed it) is that BullionVault is the only customer of this major firm to trouble it with the hassle of delivering the actual physical bars.

Trading gold on the ledger is cheaper and faster for banks, and it is natural - if sometimes wrong - for banks to think themselves 100% credit-worthy. With so much gold out there being unallocated investors should be careful because a financial crisis might not be profitable for them, and it ought to be.

Paul Tustain is the founder and chairman of BullionVault.

See the full archive of Paul Tustain articles.

Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

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