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Getting Paid In Fiat Rather Than Actual Gold

Topics [ unallocated depository services store silver allocated store gold ]

DEPOSITORY SERVICES

Following on from my previous post Don’t Mistake Perth Mint Certificates For Paper Gold I had the following question from a reader:

"If there is an event (why I would be buying precious metals as insurance for) that sky rockets the price of the metals what is the chance that I will be "paid" in fiat currencies rather than in the actual metals? Especially when the currencies are plummeting and the PMs are skyrocketing. If gold will be paid in paper isn't it paper gold?"

My response to his question is that unallocated with a bank who lends your metal out certainly has a risk in the scenario you raise. If the person they have lent the metal to defaults (most possible in a depreciating currency situation), then the bank is likely to only be paid a cash amount and not get any physical back. Such cash payments would be based on prices as at the date of default and thus would not result in the full amount of ounces being recovered in a situation of skyrocketing prices.

Even if the bank does not have any problems recalling their metal loans, they still have the problem of converting their paper gold into physical and then finding a refinery or mint to transform those 400oz wholesale gold bars into smaller bars and coins suitable for you.

Contrast that with The Perth Mint, who does not lend client metal. If the price of gold rises or falls it does not impact on our profitability as everything is one-to-one backed. Also, we are a business that deals in physical precious metals. If our clients want physical delivery it presents no problem to us because we operate a factory that produces $13 billion worth of coin and bars annually (compared to $2.3 billion worth of unallocated held with us) so we have the capability to transform metal into products.

It is likely that in the scenario of plummeting currencies there may not be many people willing to sell their precious metals for paper dollars. To maintain a one-to-one backing, The Perth Mint only sells bars and coins if it can immediately use the cash from that sale to buy replacement raw metal (usually from a mine). If we face a situation where we cannot obtain replacement metal, we will not sell. We will sit on our physical metal that backs your unallocated account until the market returns to normal. It is possible that precious metal transactions will be possible in another currency but not in others and we would only deal in those where a two-way buy and sell market for metal exists.

In the situation where clients want physical delivery, but we cannot find people willing to supply replacement precious metals, we would simply convert all the semi-finished metal into coins and bars and supply them to clients. Yes, we would be left with an empty factory, but without the ability to source replacement metal on an ongoing basis we do not have a business anyway.

The above issues do not apply to allocated, as the metal behind that has been manufactured and set aside. However, a scenario which does impact both unallocated and allocated is theft. If you look behind the insurance policies covering bank as well as non-bank storage providers, you will find three issues:

1. Insurance policies have a number of exclusions such as war, riots etc.

2. They rarely fully insure. Wholesale insurers will generally only cover around $1 billion per vault. If there is a loss greater than that, then you are relying on the company to make up the difference, and many do not have the balance sheet to cover significant losses.

3. If there is a loss which is below the insured limit, many companies would still not have the balance sheet/cash reserves to immediately buy metal to cover the loss and then wait until the insurer pays out – or take the risk that they will not pay out (eg due to employee fraud or collaboration). Even if the policy is paid out it is usually done at the value at time of loss and if metal prices are skyrocketing then the cash will not be sufficient to replace all the ounces.

In the case of The Perth Mint, clients have ultimate claim on the Government of Western Australia under section 22 of the Gold Corporation Act. This government guarantee has no exclusions or dollar limits. Secondly, The Perth Mint, via the Government, has the financial capability to immediate buy the replacement metal and then collect cash from its insurers later, so there is no exposure to skyrocketing prices. Thirdly, while The Perth Mint insures its precious metal inventories as a way of mitigating the risk to the Government, clients are not reliant on this as if the insurers do not pay out then government guarantee kicks in and the Government makes good on the loss (The Perth Mint having bought the replacement metal at time of the loss in any case).

In summary, the fact that The Perth Mint is a non-bank physical producer of precious metals with the additional protection from its Government ownership means that clients are unlikely to find another custodian with a lower risk profile.

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