Gold certificates are pretty much like fiat currencies with the exception that they give owners the right to purchase gold from a pool of reserves. While this may sound like a neat way to preserve wealth using gold, there are serious risks involved in it.
Gold certificates first appeared in 17th century with the original purpose of giving owners proof of ownership for gold that are stored in bank vaults. The owner may exchange their certificates for products and services, or may hand them down to their children. Circulation of gold certificates came to a temporary halt when the U.S. government prevented its citizens to hoard the metal for private use in the 19th century. Now, gold certificates are in circulation again and are being managed by gold pool programs in the U.S as well as some banks in Europe.
While gold certificates sound like a dream for private investors who don’t want to store gold at their homes, such certificates today usually represent an unallocated amount of gold.
Unallocated pool: the biggest problem of gold certificates
The problem with most gold certificates is that they’re meant for an unallocated pool of gold. This means that most holders of gold certificates are sharing a large reserve of gold without knowing whether or not enough of the physical metal can cover withdrawals by investors who suddenly decide to trade in their certificates. Problems arise in unallocated gold pools when there’s forgery of certificates or unfair management of banks. The unallocated gold is sometimes liquidated by the provider when the need arises, making certificates one of the riskiest types of gold investment today. There’s an option to turn a small amount of unallocated gold to allocated but the fees associated in doing it defeats the cost-effectiveness of gold certificates.
If you can’t hold your gold, you don’t own it. That’s what probably Germany felt when it was denied an audit of its own gold reserves in New York by officials from the Fed, leading to the whole Germany repatriation program. BullionVault points out that keeping gold investments close is important, since there’s no reason to invest in the metal if people can’t liquidate it quickly in times of emergency. Gold certificates backed by an unallocated gold pool simply don’t offer the same security that the actual metal gives in times of economic uncertainty.
If you want to invest in gold, there’s no better way than owning the physical metal itself. Buying certificates or any other forms of paper gold may not come in handy when emergency arises.