Welcome to our Friday mailbag edition!
Every week, we receive fantastic questions from your fellow readers. And every Friday, I answer as many as I can.
This week, we have questions about gold and the brewing banking crisis, which I wrote about in the November 20 Inside Wall Street…
How will the unrealized losses at the major banks affect their affiliated brokerage firms? I already have a substantial portion of my assets in gold in both ETFs and physical form. Need I worry about these assets if they are in bank-affiliated brokerage accounts?
– Leon H.
Hi, Leon, that’s an excellent question. It gets into the potential ripple effects of the problems disturbing the banking industry I’ve been covering in these pages.
I’m assuming that when you mention “affiliate brokerages,” you’re referring to brokerage subsidiaries of banks.
Yes, in theory, unrealized losses at major banks can create ripple effects across their subsidiary firms in several ways.
First, it could affect the parent bank’s capital and liquidity. This could affect the resources available to the brokerage firm.
Plus, significant losses might trigger a reevaluation of risks and tighter credit. That could influence the brokerage’s operations and services.
But it’s important to note that, although the financial health of a parent bank and its brokerage subsidiary might be connected… This doesn’t necessarily mean immediate risk for the subsidiary’s clients.
This is because brokerages are usually separate legal entities from their affiliated banks.
Now, I can’t give personalized advice. But in general, here’s what I would say to all my readers.
First, as a rule of thumb, readers might want to lean towards companies that have set up their brokerage arms as distinct legal entities.
Here’s why: If the brokerage subsidiary is a separate legal entity, its obligations and liabilities remain separate from the parent bank. This helps in shielding each of the two business lines from the liabilities of the other.
This kind of arrangement is pretty standard in the industry (though there are exceptions). And it’s driven by risk management strategies and also by regulatory requirements.
For example, the Glass-Steagall Act historically mandated this separation. (I wrote about the Act in my book All the Presidents’ Bankers. I shared an excerpt you can read here.)
The Act was repealed in 1999. But many of its principles still influence how financial institutions structure themselves.
As a result, regulatory frameworks in many jurisdictions require a certain degree of separation between banking and brokerage services.
Second, in general, it’s a good idea to make sure one’s assets have SIPC protection.
SIPC is short for Securities Investor Protection Corporation. It’s a non-profit corporation that protects investors if a broker-dealer fails.
SIPC safeguards clients of its member brokerage firms, in case the firm faces financial troubles.
Gold exchange-traded funds (ETFs) are categorized as securities. For investments such as these, SIPC covers up to $500,000 per customer. There’s a $250,000 cap for cash.
So, if an SIPC-protected bank were to fail, gold ETFs would be protected within these limits.
For physical gold, the situation is a bit more complex.
If the physical gold is considered part of your investment portfolio held in the brokerage account, it might be covered under SIPC’s protection.
But if it’s stored in a safety deposit box or a similar arrangement, it would not be covered by SIPC.
Now, it should probably go without saying, SIPC protection does not cover market losses.
Aside from that, say your brokerage is SIPC-insured and your holdings are under $500,000. And those holdings are split evenly between cash and securities. In that case, generally speaking, you should have nothing to worry about.
The good news is that most U.S.-registered broker-dealers are generally required to be SIPC members. That includes those trading stocks, bonds, mutual funds, and other securities for the public.
There are certain types of brokerage firms that may not be members of SIPC, though. This includes firms specializing in commodities futures, those not trading securities with the public, or certain types of foreign broker-dealers.
If anyone is unsure about their brokerage’s status, it’s a good idea to check directly with them.
Long story short, there can be risks with how major banks and their brokerage arms are connected. But these two safeguards should give pretty solid protection.
That said, for total peace of mind, especially when it comes to physical gold, it’s a good idea to know the exact details of one’s holding arrangement and maybe talk with a financial advisor.
Hope this helps.
And for anyone looking to venture outside of physical gold and ETFs, check out this free presentation I put together. In it, I give details on my favorite gold miner today.
Correct me if I am wrong, but GLD is a leveraged ETF and doesn’t mean you will ever see an ounce of gold when stuff hits the fan. Sure, you can use it for counter risk if things go south with stocks, but then the ETF may head south too for a while. Personally, I prefer to have the physical metal under my control.
– William C.
Thanks for that great question, William. To catch up other readers, GLD is the SPDR Gold Trust (GLD), which I mentioned on November 20.
Just to clear things up, though, GLD isn’t a leveraged ETF.
What leveraged ETFs do is try to give you double or triple the daily performance of whatever index they’re following.
But GLD? The value of the fund’s shares closely tracks the price of actual gold bullion (minus any fees it has).
And, yes, it does this by being “physically backed” by gold. This means that GLD shares are linked to the actual metal sitting in vaults in London.
A word to the wise, though. And this is the part you’re right about, William…
Even though GLD is “physically backed” by gold, most investors won’t be able to redeem GLD shares for physical gold bullion. They can only sell them on the market. Only those who deal in blocks of 100,000 GLD shares can arrange to get that done.
The “physically backed” part just means that GLD shares are guaranteed by the actual metal sitting in the vaults. Each GLD share represents about 0.093 ounces of gold.
This is something all gold investors should keep in mind. Because it’s not just GLD. With many gold ETFs, when you redeem them, you don’t get physical gold. You receive the cash equivalent.
Still, I like GLD not only for the reasons I outlined earlier. But also because of its long-standing history and demonstrated reliability.
Keep in mind GLD was the first gold spot ETF. Ever. When it debuted in 2004, it made a huge difference. Why?
It democratized investing in gold.
We may take it for granted today, but back in the day it made it easier and cheaper for people to hold gold in their portfolios.
It also legitimized gold in the eyes of investors.
That’s because, for the first time, it provided a convenient and cost-effective way for people to gain exposure to physical gold without having to buy and store physical gold bars or coins.
This increased gold’s appeal and liquidity, breaking the perception that it was this niche relic investment accessible only to a select few. And in doing so, it set off a chain reaction of surging prices.
When GLD came out in 2004, you could buy one ounce of gold for less than $450. Seven years later, the price of gold had soared to almost $2,000 per ounce.
To sum up, I believe GLD provides a great way to own gold without all the hassle that comes with buying physical gold. That’s, of course, as long as you don’t mind never seeing or touching the metal you’re buying.
The fund is listed on the New York Stock Exchange. So you can buy it through your brokerage account.
For anyone who values holding actual gold, I’ve mentioned popular coins in the past – such as American Eagles and Canadian Maple Leafs. I wrote about that, along with other physical gold alternatives, in this essay.
But bear in mind that coins are typically priced at a premium to the gold spot price. And you also need to consider how best to store your coins, which could add to the cost of ownership.
And that’s all for this week’s mailbag. Thanks to everyone who wrote in!
If I didn’t get to your question this week, look out for my response in a future Friday mailbag edition.
I do my best to respond to as many of your questions and comments as I can. Just remember, I can’t give personal investment advice.
And if there are any other topics you’d like me to write about, I’d love to hear from you. You can write me at [email protected].
Happy investing… and have a fantastic weekend!
Regards,
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Nomi Prins
Editor, Inside Wall Street with Nomi Prins