Unallocated gold is a bookkeeping device by which a bank or other enterprise provides you with notional gold. The gold is a liability to you on their balance sheet. It is synonymous with gold 'accounts' and its holders are unsecured creditors.

It arises from an important legal difference between the terms under which banks look after their customers' valuables. Unallocated gold is formally a deposit, which becomes the bank's property and its liability to you as a depositor. The alternative agreement style - known as allocated - obliges the bank to hold your gold as your outright property, under a custodial or safe-keeping contract.

Under the law a liquidator returns your formal property to you if a bank fails. But where it is your asset - like unallocated gold (not your property) they almost certainly cannot return it to you. Instead you would be in a pool of unsecured creditors waiting to see what cash the liquidators might raise in selling all the bank's assets. This sale would include non-performing loans, derivative and bond portfolios, and whatever stock of gold you might think was backing your unallocated gold account.

This is because it is the law that in liquidation no general creditor can be given preference over another. So the important thing with a private bullion reserve is to not be a creditor, but an owner.

As part of a bank's working capital, and under normal commercial pressures, banks will usually put their unallocated gold to use, although it is not always easy to see how.

As a simple example they might buy a gold futures contract. This would allow them to enjoy (i) a balanced gold position, (ii) a small risk that the futures clearer might fail, and (iii) your money to be lent elsewhere for profit. This is a very cost-effective solution for a bank which sells you unallocated gold.

However many gold investors require and get an assurance that unallocated gold is kept in physical form in a vault - albeit not specifically in their name - so clearly their bank does not buy futures.

This idle stock of gold is still useful to the bank even then. This is because bank regulators require the bank to maintain a highly liquid reserve against potential future problems - a reserve which they can quickly sell to raise cash in difficult times. A bank cannot treat your property is its reserve, but if you are a depositor (i.e. a holder of unallocated gold) and the gold is legally not yours but the bank's, it can. In fact it is obliged to sell such a reserve stock if it is in the interest of its unsecured creditors in general.

While credit dependencies and the financial system remain sound unallocated gold is generally safe. But even when held in physical form it is at risk of being turned into cash to be used to pay the bank's most demanding creditor if a bank is in crisis. This is how unallocated gold could link you to the world's credit system, with its thousands of dependencies unrelated to gold.

Unallocated gold and the spot gold price

Banks encourage retail gold buying customers to remain permanently unallocated by charging fabrication, transportation and custody charges to customers demanding physical delivery. Those charges are particularly high where purchases cannot be delivered in exact multiples of good delivery bars (a 400 oz bar = $160,000 at $400 per ounce).

Added to this there is within banks a natural enthusiasm for gold credit - as opposed to physical gold. Bankers tend to believe in bank reliability, and provided unallocated gold is never called upon for its reserve qualities it is certainly more financially efficient than allocated gold.

As a result the unallocated system is now so successful that daily 500,000 ounces are traded inter-bank in London on an exclusively unallocated basis. This market is many times bigger than allocated gold and for this reason it has become the de-facto basis of gold's spot price.

BullionVault does not provide unallocated gold. All its gold is delivered in physical form. It is held as the outright property of the service's users. It is available in single gram multiples, and is not required to be moved at the buyer's expense in settlement of a sale. This generally makes it more valuable to buyers than spot gold.