How safe is investment in financial gold?
Moneylife Digital Team 20 December 2011

Recent events in the US should be a cause for worry for those who have been investing in paper gold

Gold has been attracting huge amounts of money in recent times with the metal having risen from around $250 per ounce to about $1,600 now. Investment in gold is supposed to be to a protection against inflation and severe negative events. But what if gold itself is unsafe in the new financialised world in the very system you believe in? While this seems unlikely, given our faith in market structure and regulations, certain events of the last few days have got many savvy US investors worried.

Grant Williams, a fund manager recently wrote in his newsletter (Things That Make You Go Hmmmmm), an interesting analysis of the extraordinary activities in the gold futures markets which can cause a market breakdown and a loss of faith in the capitalistic system, the bedrock of which is ownership right.

Recently, MF Global had filed for bankruptcy. According to the Mr Williams, the bankruptcy trustees had decided to pool all the various customer assets, including gold warehouse receipts which are considered safe, in order to make good on the last minute margin call.

According to weekly newspaper Barron’s, the trustee overseeing the liquidation of MF Global has proposed dumping all remaining customer assets—gold, silver, cash, options, futures and commodities—into a single pool that would pay customers only 72% of the value of their holdings. In other words, while traders already may have paid the full price for delivery of specific bars of gold or silver and hold “warehouse receipts’ to prove it they’ll have to forfeit 28% of the value.

This was an extraordinary step. An exchange, such as COMEX, where gold futures are traded, provides the framework to which its members are supposed to strictly adhere to, for the safety of all parties involved. In other words, exchanges essentially provide insurance from counterparty risk. In any regulated market, investor protection is of paramount importance and the rules ensure that consumers are treated fairly. But the actions of MF Global, a newly bankrupt entity, have made it impossible to continue with this belief, according to Mr Williams and a few others.

If a firm needs to meet a margin call, it needs to be paid from the firm’s accounts and not the investors’ accounts. MF Global presumably had no cash of its own, so it used its customers’ money to fulfil its own obligations. Hence, the $100 of warehouse receipt of gold bullion thought to be safe in the futures market warehouse, vis-a-vis the bankrupted firm, is now worth at least $72, not due to underlying fundamentals of gold.

Interestingly, the selling in gold and silver accelerated before this announcement by the trustee. Gold had crashed from $1740 an ounce to $1590 per ounce, an 8.5% decline, in a matter of days before the news of MF Global’s gold sales came out. In effect, physical gold and silver as well as COMEX warehouse receipts (which are as good as physical ownership) were pooled by the trustees and sold at a price that have already sharply fallen in the futures market!

Did some powerful forces, knowing that the MF bankruptcy trustees are going to sell gold belonging to customers, sell in advance? To add further insult to injury, MF Global supposedly charged its bullion customers for “storing” gold when in effect it had stolen the same from them and sold it. Double whammy.

The exact details of what transpired between the bankrupt firm and the unknown parties, through COMEX, are unknown. It seems even COMEX is clueless and is scrambling, at the moment, to find out what actually happened and how the transaction slipped through. Commentators wonder if COMEX was involved. They certainly hope not.

bhadresh r shah
1 decade ago
Can this happen in india ?

because our ETF's are trustees not owner


bhadresh r shah
Merchant MS
1 decade ago
Buy, feel touch gold. The mere touch takes you to seven heaven. Check for purity and see hallmark logo. ETFs difficult to digest.
1 decade ago
Buy physical gold rather than gold etf. Mutual funds don't know what they are selling
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