The advantages of this method are considerable: you avoid the risks inherent in storing the metal yourself (transport loss, fire, and theft); you can buy or sell just a few ounces of gold and silver at a time; you escape the big bid-ask spreads associated with coins and small bars; and perhaps best of all, storage is usually free.
To provide those benefits, a precious metals dealer buys and sells small quantities of gold and silver to and from its customers throughout the business day. When it needs more metal, it will buy it in the wholesale market. Or when the dealer has more metal than it wants to carry for its own account (because its customers have been net sellers), it will unload the excess in the wholesale market.
Many dealers that offer unallocated storage will accommodate customers who want to convert their metal into bars or coins and take delivery. The dealer will charge a so-called "fabrication fee" for this service. The dealer won't actually pick up a hammer and manufacture the bars or coins the customer wants; instead, the fee represents the price difference between buying 100-ounce or larger bars and buying small bars or coins.
Unallocated storage is an attractive option, which is why we have recommended it to Casey subscribers for a portion of their gold and silver holdings. Of course, there's no such thing as a free lunch, so we wouldn't want anyone to rely too heavily on unallocated storage or on any one dealer that offers it. Here are some of the things that might go wrong.Wholesale fraud. A dealer might be a 100% hoax. It may not actually have the metal that customers have paid for, in which case the customers would get hurt. The proprietor would be committing a go-to-jail-forever crime, but it would be easier to pull off, perhaps for many years, with unallocated storage than with allocated storage. A customer who's bought metal in allocated storage can visit his gold or silver and check the serial numbers on the bars. A customer who's bought metal in unallocated storage may be allowed a tour of the vault, but all he's going to see is a whole lotta gold and a whole lotta silver.
Employee embezzlement. An honest dealer might have a dishonest employee. If the dealer's financial controls were lax, the employee could siphon off metal for himself or a confederate. Or if the dealer's physical controls were lax, the employee could swap bogus bars for real ones. If the embezzlement exceeded the dealer's net worth plus its insurance, customers would get hurt.
Bad bookkeeping. Gold and silver held in unallocated storage is legally the property of the dealer's customers, not of the dealer itself. So if the dealer goes bankrupt, the metal should not be available to the dealer's creditors. Customers of a bankrupt dealer should be able to collect their metal and walk away uninjured. That's how it should work. But if there are problems with the dealer's bookkeeping, the metal that the dealer and its customers thought was in unallocated storage could be up for grabs. The customers would have to fight the dealer's creditors to protect themselves – and they might lose.
Fabrication delays. When retail interest in gold heats up, much of the demand is for small bars and coins. This can lead to a temporary shortage of small bars and coins that makes it impossible for a dealer to accommodate customers who want to convert their unallocated gold into small pieces and take delivery. If such a thing happens when you want to convert and take delivery, you'll have to wait. It would be a small problem compared with losing part of your gold, but it would be a problem.
We offer these cautions not because unallocated storage is a bad choice, but because you will be better off if you understand what might go wrong. It's like the warning of possible side effects that is now standard with any medicine. The warning isn't a reason not to use the medicine; it is a reason to use the proper dose and to be alert to signs of trouble.
We can't say exactly how much metal in unallocated storage would be too much. The proper dose is up to you. But here's a starting point. If you have more than 20% of your gold or silver in unallocated storage with any one dealer, consider moving some of it. It could go to another dealer, or you could convert part of it to coins and take delivery.
This might be a chore, but we suggest that you go to the trouble even if the dealer has come highly recommended, even if your experience with the dealer has been entirely satisfactory, and even if you see no sign of trouble. There is a difference between an event being highly unlikely and an event being impossible. Sooner or later, an investor who neglects that difference gets hurt.
[Check out our hot-off-the-press Annual Gold Forecast Survey edition in BIG GOLD, where we interview 16 gold experts, fund managers, and authors, along with Doug Casey, about what to expect for 2011 and how to invest. It’s available risk-free here.]