Foreign investing seems to be all the rage these days. I am continually bombarded by articles on finance websites emphasizing the necessity of international diversification. And here’s the thing. I don’t disagree with these assessments.
International diversification is an important element in any well-balanced investment portfolio. This can easily be accomplished by purchasing ADRs (American Depositary Receipts) or foreign-focused ETFs (Exchange Traded Funds) and mutual funds. These securities give exposure to well-established foreign corporations that are operated according to international best practices.
But this isn’t the kind of foreign investing that worries me. Instead, I want to talk about offshore gold storage. Precious metal pundits and skeptical financial commentators often advise people to buy and store gold overseas. Their argument generally goes something like this:
The world’s financial system is incredibly over-levered and unstable. This will inevitably lead to a currency crisis in the dollar, euro, pound or yen (or even all of them simultaneously). The financial authorities will invariably respond to this financial panic by instituting capital controls, requiring the purchase of overvalued government bonds in retirement accounts or even seizing financial assets outright.
Notice that the foreign ADRs, ETFs and mutual funds I mentioned above, while claims on foreign cash flows, don’t provide any protection against this scenario. These paper assets in your brokerage account are easily accessible to desperate governments, should the need arise. That is why many tangible asset proponents recommend that people protect themselves via offshore gold storage.
However, while I am sympathetic to many of these arguments, the devil is in the details. The timing, magnitude and propagation of any global financial crisis will have a dramatic impact on its outcome. Believing yourself to be completely inoculated against financial adversity because of your overseas gold holdings is an investing conceit that most people can ill afford. Offshore gold storage is not the panacea it purports to be.
Overseas gold storage is usually couched in terms of “escaping” from your home country’s financial system. Pundits will often recommend that individuals acquire foreign citizenship and passports at the same time, in order to “internationalize” themselves. Sometimes they will go so far as to advise people make direct investments in foreign real estate or private businesses.
In any case, I am not a fan of being an “international” man. For one, you must have an incredibly large net worth to make it remotely viable, probably on the order of $10 million or more. It also presupposes that you can easily blend in with the population of whatever country you’ve chosen as your safe haven. But the locals will always be able to spot the outsider among themselves. And, if this immigration occurs in the context of a global financial crisis, those outsiders will not be well received.
But it is the idea of offshore gold storage that I dislike the most. First, the storage fees for offshore gold storage in a secure vault are often exorbitant, generally ranging from 0.25% to over 1% per annum. That might not seem like a lot, but it is a recurring annual fee that insidiously eats into your principal. 100 ounces of gold subject to a 1% storage fee will be whittled down to a mere 78 ounces after 25 years. That is not the kind of return most people are looking for on their tangible investments.
Next, chances are good that you will never actually physically see your gold if it is stored overseas. In other words, you will pay your money, but your gold may or may not be there. Obviously, choosing a reputable (and by extension more expensive) custodian for your offshore gold storage will give you a greater assurance that your gold actually resides in the vault you think it does. But remember this – fancy corporate letterhead and official-looking audits are relatively easy to forge with today’s technology. Many, many people have been defrauded by bullion storage schemes in the past and I suspect that many more will be over the coming years.
It is also relatively common for precious metal dealers and banks to warehouse gold in what is called “unallocated” or “unsegregated” storage. This is when a financial institution promises to give you your gold on demand. But there might not actually be much, or any, gold in their vaults most of the time. Holders of unallocated gold deposits are, in effect, unsecured creditors of a financial institution in the event of default or insolvency.
“Allocated” or “segregated” offshore gold storage, where specific gold bars with individually recorded serial numbers are stored in a vault, while safer, is still not without its risks. Fraud and inside jobs are omnipresent dangers in such situations. Even staid central banks have been accused of surreptitiously loaning out their nations’ gold reserves to achieve shady policy goals! The bottom line is that if you can’t physically hold your gold, you don’t own it.
Finally, if there is ever a global financial crisis of epic proportions, the ostensibly politically stable countries with large amounts of offshore gold storage – Switzerland, Singapore, Hong Kong, Australia and the U.K. – will be sorely tempted to nationalize all that treasure. This temptation will be even more acute if the country in question is suffering from a severe currency crisis. All those precious gold bars neatly stacked in secure vaults would go a long way to quelling a country’s financial panic and restoring prosperity. Yes, there would presumably be international diplomatic repercussions, but it just may be worth it, depending on the severity of the financial crisis. This may not be a likely scenario, but I think it is one that can’t be discounted entirely, either.
Now, I don’t believe offshore gold storage is completely useless. If you have a net worth of tens or hundreds of millions of dollars, there might be some value in keeping a million or two of gold bars in a Swiss vault deep underground. But for the average investor, or even most well-heeled investors, offshore gold storage is just too expensive and carries too many risks.
This is why I advocate keeping your tangible investments local. As the old adage goes, possession is 9/10ths of the law. And while precious metals are great investments, other tangible assets, like art and antiques are also great diversifiers. There is nothing quite like holding a sparkling old mine cut diamond or an ultra-rare French piedfort coin in your hand to remind you what true wealth is.
