FAQ – The Best Way to Own Gold

Few people realize that gold is actively traded on the Forex just like every other currency. In fact, even though most banks refer to gold as a commodity, they trade gold at their currency desks not on their commodity desks. As a globally recognized currency, gold has the code XAU, which is not to be confused with the gold miner’s equity index with the same three letter acronym. It is also important to note that most central banks treat their gold reserves a part of their foreign currency holdings. So it is pretty clear — despite what most financial commentators might claim — that gold is money.

The foreign exchange market, also referred to as Forex, FX or currency market is the market in which currencies are internationally traded. This is a global market, trading 24H a day, with the bulk of trade in London and New York, but also sizable trade in Tokyo, Singapore and Hong Kong.

In September 2013, the Bank for International Settlements (BIS) released their study on the size of the FX market. This study, “Triennial Central Bank Survey 2013”, reported that the average traded daily volume in the FX market, as of April 2013 was estimated at $5.3 Trillion. This combines Spot transactions, Forwards, Swaps and Options.

In the currency markets, gold has an average daily trading volume of $249 Billion, which makes it the 5th most actively traded currency in the world. In other words, every trading day $249 billion dollars worth of credits denominated in a weight of gold trades in the currency market.

This is an astounding number. Perhaps we can put it into perspective by comparing the average daily volume of Gold on the Forex market with other markets where gold trades.

• The daily volume of actual physical gold trading is around 16 tonnes or $650 Million.
• The daily volume of trading in GLD (the ETF) is around 50 tonnes or $2 Billion.
• The daily volume for the Comex is around 500 tonnes or $20 Billion.
• The FX daily volume for gold is in excess of 6,000 tonnes or $249 Billion.

When we look at these numbers it becomes abundantly clear that the price of gold is not driven by the tiny physical segment of the market. Rather, the current price of gold is the product of a highly synthetic currency trade.

Today the majority of gold investors own little more than a gold price tracking instrument — what is often referred to as “paper gold”. These credit-gold investments remain “as good as gold” only as long as they trade at parity with physical gold. Credit-Gold that trades as a currency requires, needs, and depends upon a functioning physical market which trades at parity to the credit-gold market. But the physical market does not require, need or depend upon the credit-market. This is not a codependent relationship. It’s more like a parasitical relationship, where the parasite cannot survive without the host, but the host will do just fine, or perhaps even better, without the parasite. Recent headlines indicate that this parity relationship is more tenuous than anyone might realize. In such an environment, why not own the real thing—free of parasites.

The European central banks have always been the lender of last resort in the fractional reserve practices of the gold market. As European central bank sales and leases dry-up, the credit-gold market will ultimately fail through its inability to provide physical gold for delivery. In the paper gold market, when a credit contract holder demands delivery, the bullion bank (market maker) has to borrow gold from someone else. The act of borrowing gold necessarily creates a new credit contract (a new paper gold owner). For several decades the European Central Banks have been the ultimate lender of physical gold in this chain—that is, until the acceptance of the Central Bank Gold Agreement (“CBGA”) was signed in 1999. The CBGA placed severe restrictions upon Central Bank sales and leases. With the acceptance of the CBGA, and its subsequent renewals, gold’s role as an essential wealth reserve has been secured.

This is one of those questions that leave both investors and economists very divided.

Instead of concentrating on the issue of price manipulation, we find that it is far better to understand that the current “gold market” has a structural flaw which enables market participants to interfere in the price mechanism.

Although gold is no longer fixed to any official currency in the world, it still exists as an independent currency in the Over-the-Counter market. Banks manage this “currency” in a fashion analogous to other currencies: with tangible cash, account balances, the creation of credit, lending, debt, swaps, forward and futures contracts, and a host of derivatives. Banks have the ability to, in a certain sense, “create gold” through the construction of gold-price tracking derivatives. The largest gold-derivative market is the Forex market where “gold units” are created to hedge currency price fluctuations. 6,000 tonnes of this paper-gold trades on this market every day, making it the 5th most traded currency in the world.

With the introduction of these credit-gold derivatives the gold market needed to be reorganized so that bullion banks and central banks could treat their physical gold deposits in much the same way as they treat deposits denominated in currency; as the reserve asset against which they lend additional money to borrowers. Physical gold reserves needed to be collateralized so that trading against them could be made possible.

When a bank creates “gold units” on its currency desk, it is doing so completely in a non-physical way. This is nothing more than a cash-flow event whereby a customer with surplus Forex assets requests to exchange some or all of these assets for “gold units”. What this amounts to is a tremendous amount of digital activity whereby unallocated gold deposits custodied in the vaults of the bullion banks are subjected to fractional reserve banking practices. Through an ongoing counter-party squaring exercise, the network of banks fractionalize and derivitize the physical bullion reserves which they hold in custody. In so doing, the dollar, not physical gold, has become the primary “item traded” in the gold market. In fact, the gold market has become just another currency trading arena.

The fundamental flaw in the gold market, the same flaw that we can trace through every monetary system in human history and that ultimately causes its collapse, is when the system reaches the point where a potentially unlimited number of credit-claims can be traded for a limited amount of the underlying reserves. The essence of banking is lending and lending by design creates an enormous synthetic supply of the system’s reserves. As a result, credit that can be exchanged for a fixed weight of gold regularly leads to a monetary discount whereby the value of gold is suppressed by the value of credit. In other words, if the value of credit that trades as currency is tied to a weight of physical gold, the creation of credit in the banking system leads to physical gold trading at a monetary discount. When gold trades at a monetary discount, the rational response has always been to take possession of the gold, leaving behind only the collapsing credit claims.

With this in mind, is it any wonder that nations like China, Russia and India are accumulating physical gold at an astronomical pace? And what about the global central banks—why are they purchasing physical gold hand over fist?

Precious metals, such as gold and silver bullion, can sometimes be preferable to financial assets due to their lack of counterparties. Securities, derivatives, and ETF products can be complex and opaque products with associated counterparties which brings a degree of risk with them. This is why Swiss bankers have traditionally advised their clients to hold a minimum of 10% in tangible assets, such as allocated gold bullion. By investing in tangible investments in your Clear Title Account you hold legal title of your assets without counterparty risk.

Gold bullion has a millennial record as a store of value and remains the most widely recognized and universally accepted valuable in the world. It is the only tangible, non?financial asset that is always liquid and practical to own without involving the financial system. This unique combination of liquidity and independence from currencies and financial institutions is why central banks around the word hold a portion of their reserves in physical gold.

Such diversification makes perfect sense ? “reserve” is something one must rely upon if conventional arrangements fail to perform, which is why reserve holdings must be fully de?correlated from the risks inherent in conventional arrangements. In the case of investment portfolios, “conventional arrangements” revolve around financial assets, currencies and the financial system.

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• Compare the various ways to invest in gold.

Financial derivatives, such as futures and options contracts can be highly complex, opaque and involve a great deal of hidden leverage. Derivatives are contracts between two parties for speculation or hedging. Investing in gold derivatives is a speculation on the movement of the gold price and not an investment in the metal itself. Problematic risk considerations include:

• Excessive amounts of leverage to gold prices
• Problematic volatility above the live gold price moves
• Complications and delays of opening professional brokerage account
• Owning a derivative not physical gold bullion
• Broker and default risk

Gold is not a paper credit. It is not a contract for future settlement. It is not a position in a highly leveraged trading structure. Gold is a real and tangible asset. All paper-credits and investment securities are actually a short position on physical gold.

The vast majority of wealth today remains concentrated in financial instruments within a highly correlated system that is vulnerable to financial and systemic failures. In the event of another systemic shock, any and all contracts will be swept along within the consequent financial and economic upheaval. It makes no difference if they are contracts for gold, currencies, bonds, or stocks. All of them will lose value since they are tightly bound within our highly correlated and counterparty dependent system.

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Precious metals ETFs should be viewed as investments that track the price of bullion. They may be useful for speculation but they do not offer ordinary investors title to a specific quantity of allocated gold, or physical delivery options. This exposes you to counterparty risk, which is inherent to “paper gold” products. In contrast, holding gold or silver in a Clear Title Account is free of counterparty risk.

It should be noted that you are not actually purchasing the bullion nor can you ever redeem the full underlying value of your shares in physical bullion with an ETF. In addition, you may be paying a significant premium when you purchase these investments.

There are other risks involved with ETFs that include lack of transparency, lack of answerability and possible asset exposure due to the fact that the bullion is usually not insured. It is highly recommended that, prior to investing, you become familiar with the risks involved with these trading vehicles by reading the risk disclosure statements contained in their prospectus. The ETF structure has never been fully stress tested and your gold investment can have as many as four financial counterparties associated with it. These problems, amongst others, could put your assets at risk when you need them most and would therefore invalidate the very reasons for owning bullion as a hedge in the first place.

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A leveraged bet on the gold price with a financial counterparty is very different and perhaps far more speculative than owning physical gold bullion. When the gold price is volatile such a degree of leverage can quickly work against you.

A spread-bet may not be a sensible way to invest in gold, because all you own is an electronic bet on the gold price without owning the tangible asset. Individuals typically look to buy gold bars to diversify away from the counterparty risk of the financial system.

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Owning gold mining shares is sometimes suggested as a way to invest in gold. It is cited as a way to achieve leveraged exposure to the gold price. However owning shares of a gold mining company is very different than owning allocated physical gold bullion. When you own a gold miner you are exposed to a range of new risks.

• Exploration risk: the risk that the gold miner is very poor at finding gold reserves.
• Extraction risk: the risk that the gold miner may have lower quality gold mineral reserves than thought, and that it may be more difficult than planned to get these gold ounces out of the ground.
• Jurisdictional risk: the risk that the authorities in the countries the gold mines are located in will prevent your company from getting its gold bullion to market.
• Management risk: the risk that the management of the gold mining firm is fraudulent or poor at growing the company and the share price.
• Energy and input costs: the main costs of gold mining are the costs of energy and mining equipment. When the prices of oil and steel go up this can seriously affect the profit margins of gold miners.
• Exchange rate risk: exchange rate movements can greatly affect mine profitability by creating currency translation adjustments. This could wipe out the profits you hoped to realize.
• Lack of dividend: gold miners have typically been very poor at issuing dividends to supplement the performance of their share price. This has helped to limit the popularity of gold mining shares as institutional investors looking for a yield on their gold investment have stayed away.

If you are looking to invest in gold for security and diversification, owning gold mining shares may be too speculative.

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Some investors buy gold coins that they keep in their personal possession for emergencies, but investing in bullion on a secure platform may be a better option for a more substantial gold investment. Coins allow you to own gold and silver in a defined, small form. Coins held in your own possession are instantly accessible should the immediate need arise, making them a form of financial catastrophe insurance. However, due to the manufacturing (minting and fabrication) and shipping costs, purchasing gold and silver in the form of coins is considerably more expensive per ounce to purchase than the larger bullion bars. This added margin is usually lost should you decide to resell those coins. As with any valuable, there are safety, storage and liquidity issues to be considered.

Under the Currency or Coinage Acts of most nations, the government (and/or central bank) at all times directly owns the coins and notes issued in that country. This means that if you purchase a bullion (gold or silver) coin issued by a government, you are only the BEARER of the coin, and never the outright owner. The issuing government owns the coin. Should the government decide to recall that coin, which they can do at any time they wish, they will pay you for the face value of the coin, and not its true metal value. Governments have a long history of recalling bullion coinage when their economies head into rough times, a recent example in the western world being 1933 in the US.

Though it might be wise to hold gold and silver coins at home for emergencies, investing in bullion on our secure platform is a better option for more substantial gold and silver investments. Your investment is made more efficient since we give you the ability to buy and sell on the Primary Market at the Spot Market price. Coin dealers will reference the spot price in their calculations but they often add a substantial premium on purchases and a substantial discount on sales. When you use your Clear Title Account, you get more gold for your money when you buy, and more money for your gold when you sell.

Your investing through our Clear Title Program makes your gold and silver investment highly liquid since you can buy and sell in the global market with a two-day settlement period.

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• Compare the various ways to invest in gold.

Strategic Gold Corporation offers you the simplest, most convenient and cost-efficient way to purchase, store and sell your investment grade Good Delivery Standards bullion bars of gold and silver. Dealers typically do not offer storage facilities for your bullion. You would have to store your bullion at home or in a safety deposit box. Either way your bullion is at risk and is usually uninsurable.

Furthermore, every sound investment must be made with consideration for an exit strategy. If you decide to sell your bullion, it will require a costly re-assay in order to be sold. In addition, you may not receive a fair price for your bullion assets. Because Strategic Gold stores your bullion in a certified LBMA vault thus guaranteeing that the Chain of Integrity is not broken, the provenance of your bullion holdings are assured and your bullion is completely liquid meaning it can be instantly sold without the need to re-assay.