So Texas wants to build a bullion depository. Welcome to the club – The
Perth Mint, wholly owned by the state of Western Australia, has been offering
storage services to locals and overseas investors since the 1980s. Is it a
smart idea or a fiscal folly pandering to doomers and preppers, as some
in the mainstream media imply?
While being used to mainstream media derision about gold, I was surprised
at the way the media made fun about Texas’ move, some examples:
- Bloomberg: Texas wants its gold back from the
Yankees, wherever they’re keeping it.
- LA Times: Whether you call them visionaries or call
them chuckleheads
- Talking Points Memo: And in case the Fed or Obama
wants to confiscate Texas’s gold, nice try Fed and Obama!
So much for journalistic objectivity but it certainly doesn’t help if
Governor Greg Abbott can’t get the location or value of the University of
Texas Investment Management Co’s (UTIMCO) gold right. While the media were
happy to make fun of goldbugs, operating a depository is not a “perhaps generating revenue for
the state” business.
For example, over the past 10 years The Perth Mint has generated $212,661
million in profit before tax and paid $164,299 million to its state
government. Yes we do operate a refinery and mint in addition to a depository
facility, but these figures show that a precious metals business can be
profitable.
The key to profitability is scale, as margins in all aspects of the
business are very low (the average profit margin before tax for The Perth
Mint over those 10 years is 0.7%). In the case of a standalone depository,
scale is even more important as it involves a large fixed cost (the building)
compared to ongoing operating expenses (whether you hold $1 billion or $100
billion, the staff to watch it are pretty much the same).
Texas’ Legislative Budget Board Fiscal Note estimated first year costs of $10 million and
ongoing costs of $4.5 million. While one could build a sizable depository for
$10m, the estimate of 71 staff (which I guess is behind most of the $4.5m) is
way out, even if it did include an electronic gold payment system.
If we assume a capital cost of $10m with a low depreciation of 20 years,
then that is $500,000 a year. With UTIMCO reportedly paying less than
$1m a year on its $500m worth of physical gold, the Texas depository is
already looking good. Conservatively I would think they could get another
$500m of institutional business and in terms of retail, considering that The
Perth Mint stores $2.7 billion, Bullion Vault $1.5 billion and Gold Money
$1.2 billion, a target of $1 billion in retail deposits is achievable,
particularly since Giovanni Capriglione said that “when I first announced this, I got so many
emails and phone calls from people literally all over the world who said they
want to store their gold … in a Texas depository.”
Together that totals $2b, which at a 0.2% storage rate is $4m. Less $0.5m
depreciation, insurance and operating costs that is a profitable business.
You may not think those numbers sound like much, and that is true, but think
about the 700 tonnes of gold stored for the GLD ETF. At 0.1% storage fee that
works out to around $27m. In a depository business once you start talking
volume almost every dollar of additional storage fee revenue is pure profit.
While we are on fees, just let me indulge in a side rant at the LA Times
who thinks that “bullion is expensive to store because it requires
rock-solid security” – a 0.1% to 0.2% storage fee is less than many
management fees on mutual funds. A no, gold does not need “to be
regularly assayed to establish its purity, especially if it’s moved, unless
under painstaking chain-of-custody conditions” – professional
custody process are simple and involve no “pain” for investors.
Back on topic, I note the inclusion of anti-confiscation wording
in the bill, which demonstrates the Government’s support and backing of the
depository and this is similar to how the West Australian Government included
a Government Guarantee covering The Perth Mint’s operations
into its legislation. I think this is an important and necessary
inclusion to build trust in the facility.
You may be surprised at why I’m OK with another competitor, but I think
Texas’ move will grow the market rather than be a case of just splitting up
the same gold pie into smaller slices. I also get where Texas is coming from
– culturally Texas and West Australia are similar, particularly in how they
relate (or not) to their federal government. For example, in 1933 68% of
West Australians voted to secede from our Federation. Texas has a good
chance of success with its new depository and I think it will be good for
gold and the gold industry.
