How Gold & Silver Coins & Bullion Can Help Eliminate Counterparty Risk
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How Gold & Silver Coins & Bullion Can Help Eliminate Counterparty Risk
What the FTX is happening? Unless you’ve been living under a rock, don’t necessarily follow the financial markets, or have been locked away hodl’ing your gold and silver coins, you’re likely familiar with the recent implosion of the cryptocurrency market trading exchange, FTX. Until recently, FTX was one of the largest crypto exchanges by volume.
At the time of this writing, the value has collapsed by approximately 95%, and by the time everything is said and done, will likely be worth nothing. Nothing! Let’s add a little perspective to this.
A few short weeks ago, this company had a value of roughly $32 billion and was run by a 30-year-old billionaire who started the company three years prior. In three years his company was generating billions! Now, think about all those who were using FTX for their crypto exchanges. Let’s be honest, dealing in crypto is not for the faint of heart to begin with.
Trust issues aside, there is also counterparty risk to consider in these types of investments which is the focus of this article.
For those of you who may be unfamiliar with the term, counterparty risk is the risk of another party failing to fulfill their fiduciary responsibilities and potentially defaulting on their obligations. It’s a bit easier to understand if we break this down a bit. First, a transaction requires a buyer and a seller. This makes them the counterparty to each other.
Each party has an obligation to fulfill. The seller must provide what is being sold and the buyer must provide the funds to purchase. There is always a risk that one of those fails to deliver. This is known as counterparty risk.
The good news is investing in gold and silver coins or bullion can potentially reduce that risk as part of your portfolio.
In regards to FTX, a new CEO has since been hired to work with regulators while they sort out the details, but his initial findings have revealed massive fraud, incompetence, and a complete lack of controls. Unfortunately, these findings have decimated the value of corporate and individual investment holdings alike.
In fact, it’s estimated that there could possibly be a million creditors, which means that litigation will likely be dragged out for years with many individuals receiving only a fraction, if any, of their original investment in the company. Ouch.
We aren’t necessarily anti-crypto like Peter Schiff, one of our favorite financial podcasters, but this does raise the question of counterparty risk levels.
The reality is that it’s nearly impossible to avoid or eliminate counterparty risk in investments. In fact, years ago we were victims ourselves of an investment opportunity that sounded promising but ended up being a Ponzi scheme. Needless to say, we’re now highly skeptical of any investment opportunities that are presented to us.
Thankfully, when you have physical gold and silver in your possession, such as gold and silver coins, there is no counterparty risk because you are not dependent on someone else to fulfill their end of the bargain. The purchase has been made and you have the items in your possession.
Now, if you don’t receive the precious metal at the close of the transaction for any reason, you could increase your counterparty risk.
In light of the current FTX debacle, we thought it would be an appropriate time to explore this topic in further detail and highlight some of the various ways that individuals can invest and store their gold and silver while highlighting the counterparty risk of each option.
Gold & Silver ETFs
One of the more popular ways to invest in gold and silver is through exchange-traded funds (ETFs), which are available for purchase through brokers. The most popular and regarded gold and silver ETFs in the marketplace are GLD and SLV, respectively. These investments are traded over-the-counter (OTC) versus on traditional stock exchanges. They are derivative contracts that derive their value from the underlying commodity, that being gold and silver, and are a proxy for the gold and silver markets.
While this is a relatively inexpensive way to invest in gold and silver, it is fraught with potential counterparty risk, which we’ll discuss in further detail.
Counterparty Risk of Gold & Silver ETFs
You don’t actually own the physical gold and silver in the fund.
Many ETFs are highly leveraged and aren’t fully backed by precious metals.
It was recently revealed that 50% less silver than originally believed is eligible and available for physical delivery.
ETFs are merely a proxy for physical gold and silver. They don’t necessarily reflect the price of physical gold and silver.
In theory, gold and silver ETFs could become worthless, while physical gold and silver never will.
Gold & Silver Mutual Funds
Gold and silver mutual funds are also a popular way to invest in gold and silver. Mutual funds are investments that typically invest in a basket of underlying stocks and/or that track a certain index. A good example of a mutual fund that you might be familiar with is the Vanguard S&P 500 Mutual Fund, with the ticker symbol of VFINX, which tracks the performance of the S&P 500 Index.
There are various mutual funds available, and most of them have a good bit of exposure to mining stocks, but for the purposes of our discussion, we’re going to focus on those that hold a considerable amount of their assets in physical gold and silver.
Many of the same counterparty risks exist with mutual funds as they do with the ETFs that we highlighted above.
Counterparty Risk of Gold & Silver Mutual Funds
Just as it is with Gold and Silver ETFs, you don’t own the underlying gold and silver in the fund. Rather, a share(s) of the fund, which when liquidated will pay you the dollar equivalent of your purchase.
While many of these funds are audited by third-party auditors, it may only be once a year, which means that there’s an opportunity for misappropriation of funds in between audits.
In addition to Counterparty Risk, mutual funds also have reputational risk. In other words, if the company is alleged to be involved in unethical business practices, it could see mass redemptions, of which it might not be able to meet once again leaving you empty-handed.
Gold & Silver Mining Companies
Gold and silver mining companies are also a popular way to invest (indirectly) in gold and silver. There’s no shortage of gold and silver miners in the marketplace. One of the most popular ways to invest in the gold and silver mining sectors is through indexes. GDX and GDXJ are the most popular large and junior gold miner ETFs while SIL and SILJ are the most popular and largest silver ETFs.
Investing in gold and silver mining companies or ETFs that represent the mining industry is not for risk-averse investors. These are some of the most volatile investments and can see dramatic daily swings. In fact, the volatility is similar to cryptocurrencies.
While gold and silver miners can offer tremendous upside potential, especially in a bull market, they have experienced devastating losses in others, especially the junior miners, which are more volatile than the larger mining companies.
However, volatility isn’t necessarily the focus of this article, so we’re going to mention only the potential counterparty risk in this sector.
Counterparty Risk of Gold & Silver Mining Companies
Many mining companies have exposure outside of the United States, which provides country risk. Country risk refers to the uncertainty associated with investing in a particular country, and more specifically the degree to which that uncertainty could lead to losses for investors.
In the same vein, geopolitical risk could result in the company or mine being nationalized or seized by the government.
War, civil unrest or rioting, especially in third-world countries, can cause mines to shut down for a period of time.
Unexpected strikes can also result in a temporary shutdown until the parties reconcile.
So far, our primary focus has been on investment options that provide you with the ability to participate or invest in the precious metals sector and their respective counterparty risks. The drawback of these investments, of course, is the ability to settle your contracts or accounts in physical gold and silver. Considering the counterparty risks listed above, we hope you now have a better understanding of how investing in gold and silver coins is a less risky strategy.
Assuming we’re all in agreement or have at least intrigued you enough to learn more, let’s move on and discuss various storage options and the associated risks with each. We hope that by the time you’re done, you’ll arrive at the same conclusion we did with respect to the safekeeping of your valuables as well as your investment options.
Safe Deposit Boxes
On the surface, safe deposit boxes appear to be a great way to store your physical gold and silver. After all, not many people have the ability to break into a bank vault, drill out the safe deposit boxes and make off with your valuables. While we’ve all seen plenty of movies dramatizing these events, the reality is that this rarely, if ever, happens.
In fact, many in our society have used safe deposit boxes for decades. In fact, my parents kept all their valuable documents in a safe deposit box, as it was perceived that this was the safest place to keep them. The thought was that it was nearly impenetrable to theft and the risks of fire and water damage.
It’s nearly impossible for bad actors to break into safe deposit boxes, the elements appear to be of limited concern, and the boxes are climate controlled. So, how could there possibly be counterparty risk associated with this option? Surprisingly, there are a few risks that you may not have previously thought of.
Counterparty Risk of Safe Deposit Boxes
The bank could change its policy on the permitted use of the safe deposit box. In fact, some banks no longer permit the storage of precious metals or cash in safe deposit boxes.
A natural disaster could result in the opening of safe deposit boxes. We were once told secondhand that a safe expert was instructed to drill out depositors’ safe deposit boxes in New Orleans following flooding and hurricane damage from Hurricane Katrina.
The bank could go bankrupt, as we saw many banks do during the financial crisis in 2008 – 2009. New ownership may not have the same policies with respect to the permitted use of safe deposit boxes.
Limited access to your safe deposit box. New ownership, a natural disaster, a banking crisis, a pandemic, capital controls, etc. could all limit your ability to access your safe deposit box, during which you may need immediate access for liquidity purposes.
In light of some of the issues noted above, private depositories appear to be a great option. In theory, these depositories provide you with 24/7 access to your gold and silver, aren’t influenced by what happens in the banking system, and have limited exposure to government policy, such as the passage of Executive Order 6102 by FDR making it illegal for U.S. citizens to own gold.
While many of these are valid points, exposure still exists with private depositories. Many of you may have read about a Beverly Hills depository that was raided by the Feds in March of 2021. The owners of the vault, as well as some of the vault holders, were alleged to be involved in illicit activities and the assets of all 369 safe deposit boxes were seized by the FBI.
While most of the depositors had nothing to do with illegal activities, in many cases, they were required to provide evidence that the assets were legally obtained before the items were returned. In other cases, a settlement was reached to avoid the unnecessary time, expense, and potential embarrassment of the safe deposit box holders by litigating the matter.
While we’ve given away one of the largest counterparty exposures with this option, there are still others, which will discuss below.
Counterparty Risk of Private Depositories
As stated above, the most obvious potential risk is illegal dealings by the owners of the depository resulting in the potential seizure of your assets
Not only does risk arise from seizure by government officials, but bad actors could access safe deposit boxes of customers that are suspected of having valuables in their units.
A government order may require the owner of a private depository to limit or prevent access to the depository
Coin Dealer Storage
Many coin dealers offer their customers depository or vaulting options, which helps to eliminate the need for buyers of physical gold and silver to identify storage options on their own. There are typically two options available to investors: allocated and unallocated.
Allocated means that a customer purchases specific coins or bullion, which are held by the coin dealer in their vault for safekeeping.
Unallocated means that a customer has made a purchase or has an ownership interest in a pool of physical gold and silver as opposed to a specific item.
For example, the Perth Mint offers both options. You may choose to purchase a monster box of Australian silver kangaroos and have the mint vault these coins for you, which would be allocated. Alternatively, you may decide to make a purchase in unallocated silver bullion, which will have a reduced storage fee, if any at all.
With respect to the unallocated option If you choose to take physical possession at some point in the future, it may take a few weeks for the silver to be fabricated, which will in part be based on how much physical silver the mint has on hand and their ability to meet redemptions.
In general, the counterparty risk of having a coin dealer store your valuables is similar to that of a private vault or depository, but some unique exposure exists, which we’ll discuss in further detail below.
Counterparty Risk of Coin Dealer Storage
The most obvious counterparty risk is associated with the coin dealer or mint failing to allocate physical gold or silver as they’re required to. Routine third-party audits help to reduce this exposure.
Unallocated purchases are just as risky, if not more so. The temptation exists for unscrupulous companies to sell gold and silver that they don’t have on hand in hopes that few, if any, customers will request physical delivery of the product.
A failure of checks and balances or a lax protocol could increase the chances of theft by the company’s staff.
A government order may require the company to put a hold on all redemption requests until, or unless, it is reversed.
Overseas/Cross Border Storage
Some precious metals experts, such as Peter Schiff and Doug Casey, recommend overseas or cross-border storage for physical gold and silver; at least for a portion of one’s holdings. The thought is that if we were to see a repeat of Executive Order 6102 making it illegal for U.S. citizens to own physical gold and silver, you would still have access to a portion of your precious metals holdings outside of the country.
In theory, this seems to be a sound strategy, but it also is not without risk. The world that we currently live in is much different than it was at the beginning of 2020. Prior to Covid, international travel was prevalent, and as a U.S. citizen, you have one of the best passports in the world. As of July 2022, the U.S. passport was tied for 7th among the most destinations available at 187. The Japanese passport is considered the top passport in the world with access to 193 destinations, only six more than the U.S.
Since Covid struck in March of 2020, international travel has been limited. Even at the time of this writing, many U.S. citizens are precluded from traveling to certain countries without a vaccine passport. Considering that an estimated one-third of U.S. citizens have not been vaccinated, this may limit their international travel indefinitely; especially if we’re hit with another pandemic. You may have seen this recent headline, but the G-20 is proposing a vaccine passport for all future international travel.
The ability to physically travel to the country where your precious metals are stored is the greatest risk, but there are others, which we’ll highlight below.
Counterparty Risk of the Overseas/Cross the Border Storage
The financial system in other countries is not as regulated as it is in the United States, which could increase the risk of theft from overseas safe deposit boxes or depositories and reduce the potential recovery of such thefts.
At one point, there were rumors that a foreign government mint was unable to meet unallocated precious metals redemptions. This could result in a run on the mint’s physical gold and silver holdings.
Most bank accounts outside of the U.S. are reported to U.S. authorities, which means if there’s a ban on physical gold and silver in the United States, they could instruct their foreign counterparts to put a hold on your assets.
Everywhere you look there appears to be counterparty risk with respect to physical gold and silver coins. At Atlanta Gold & Coin Buyers, we believe that if you don’t hold it, you don’t own it. We recommend eliminating or greatly reducing counterparty risk by handling storage of precious metals yourself.
We have heard some pretty creative ways over the years of how our customers choose to store their precious metals. Regardless as to which option you choose, the key is to be able to have relatively easy access in the event you need them.
Certainly, a financial or economic collapse, a rapid depreciation of the dollar, hyperinflation, a bank holiday, capital controls, or the adoption of central bank digital currencies (CBDC) are all reasons why you may want quick and easy access to your precious metals.
We have talked in the past about using physical gold and silver for bartering purposes, which is a possibility, at least for a period of time, following a dollar collapse and until a new widely accepted currency is established.
We’ve gone into quite some depth regarding gold and silver investments as well as various storage options.
We began our discussion with ETFs and mutual funds, discussing the derivative exposure of these investments and how they don’t provide you with the option to redeem your position in physical gold and silver. We then talked about the geopolitical and volatile investment risks of mining companies, especially those with significant exposure outside of the United States.
We then shifted our discussion to storage or vaulting options, including bank safe deposit boxes, private depositories, and vaulting options offered by coin dealers. In our opinion, you’re better off opting for allocated storage, as opposed to unallocated storage, which increases your risk. Unallocated purchases provide you with ownership of a pool of precious metals, which could result in redemption issues down the line. We also suggest you confirm that they carry insurance and that your holdings are 100% segregated.
We then wrapped up our discussion with overseas options. While diversification outside of the U.S. may be a good idea, there are also risks with this strategy, including your inability to travel to the vaulting destination, the potential for theft in a less secure facility, and the ability of governmental authorities to influence foreign banks’ decision with respect to access to your physical gold and silver.
At the end of the day, you should have quick and easy access to your gold and silver holdings (at least a majority of your holdings), so we recommend that you develop a strategy that provides security as well as easy access to your valuables when you need them most.
While we don’t provide depository or vaulting options, we deal in the most popular and widely traded gold and silver coins and bullion in the marketplace.
If you’ve made the decision to invest in gold and silver coins as a hedge against these exposures, including others, contact us today at 404-236-9744 for industry-leading service and expert advice.
We look forward to hearing from you and earning your business.
Tony Davis is the owner of Atlanta Gold & Coin Buyers, a full service Atlanta based coin and bullion dealer specializing in buying, selling and appraising coins and coin collections of all types and sizes.
Tony frequently writes on various economic and numismatic related topics affecting the coin and bullion markets and has been published on some of the industry’s leading websites, including Coin Week, the American Numismatic Association, Coin Collector, Coinflation, and Coin Auctions Help, just to name a few.
Visit Atlanta Gold & Coin’s website at atlantagoldandcoin.com to obtain additional information on the products, services and educational resources offered by his company. Tony can be reached at email@example.com or at 404-236-9744