Last Updated : 19 July 2012 at 15:25 IST
The precious metals risk pyramid
Source :BMG Bullion Inc
For a bullion product, be it a fund or actual bullion bars, to earn its place as the foundation of a portfolio, the bullion purchaser must demand documentation that legally transfers title of specific, physical bars directly to them
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In the precious metals space, there are several options luring the discerning investor but the Precious Metals Risk Pyramid developed by Bullion Management Group (BMG) gives an idea of the relative risks involved in such newer offerings as against the security offered by physical bullion and its near substitutes.
The increased interest in precious metals as portfolio insurance has spawned a new generation of precious metals-based financial products, many of which are paper proxies or derivatives of bullion. There are even unregulated markets for the exchange of “digital gold.”
Precious Metals Risk Pyramid
The foundation of the Pyramid is Physical bullion, security is provided by pooled bullion accounts, bullion certificates, Open End Bullion Mutual Fund, Income comes from mining company, coporate bonds, Growth from producing miners shares, mining stock mutual fund, closed end mutual fund, Bullion ETFs; Speculative : Pink Sheet junior shares, Options and futures, exploration junior shares. As you move up the pyramid the risk increases. (Pictorial representation of the Pyramid at the end of this articles)
When investing in exchange traded funds, it is important for the investors to read the fine print and not to be attracted blindly by its low cost formula.
As reported by the economic news website ZeroHedge, financial services giant Morgan Stanley paid out $4.4 million in June 2007 to settle a class action lawsuit brought by clients after the firm charged them to “buy and store” precious metals, but did neither .
Similarly, a class action lawsuit filed in New York’s federal court accuses UBS Financial Services of misleading silver investors, and charging them storage fees for metals that were never purchased, let alone allocated or stored for them.
A larger problem has been brewing for several years now, that of exchange-traded funds (ETFs). These are generally viewed as a low-cost panacea that replaces almost any investment strategy, including the purchase of gold bullion, and they are giving investors a false sense of security.
This ETF structure will work during normal market conditions. However, it may result in losses and disputes if the Authorized Participants, acting as market makers, become insolvent or step aside during a precipitous decline.
For a bullion product, be it a fund or actual bullion bars, to earn its place as the foundation of a portfolio, the bullion purchaser must demand documentation that legally transfers title of specific, physical bars directly to them. Do not accept IOUs, paper proxies or derivatives. It is important to read the purchase documents carefully to ensure they convey legal title. Only after the purchaser has legal title can they enter into a binding custody agreement for bullion storage on an allocated, insured basis. In that agreement, the purchaser must be able to identify all terms and rights concerning insurance and secure, allocated storage.
Proper insurance and allocated storage in a credible, guarded vault costs money, so steer clear of bullion products promising low fees. If the deal appears too good to be true, the physical bullion may not exist. What the investor may have is paper bullion that will not offer protection when it is most needed; they may simply be an unsecured creditor of the dealer. It is hardly prudent to be tempted by low storage fees that will save a fraction of a percentage point while risking an entire bullion holding. Short cuts and penny pinching are inadvisable strategies for any asset intended as an ultimate safe haven of wealth protection.
(Excerpted from an article from Bullion Management Group Inc)
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