I picked up some shares of Sprott Physical Gold Trust on a tip from a friend who is a lawyer at a Bay Street firm here in Toronto.  What backs up Sprott Physical Gold Trust?  Its Net Asset Value (NAV) as of close Friday is $11.60 per share, based upon 820,753 oz of physical gold held in the Canadian Royal Mint.

It is possible to buy Gold certificates from major banks.  What backs up the gold certificates of banks?  Well, the Bank of Nova Scotia says,

Scotiabank gold certificates are backed by the assets of The Bank of Nova Scotia.

And this:

Allocated gold is bullion held by a bank on behalf of the owner. The gold is separated from other metal that may be held by the bank and is identifiable by its unique bar numbers.

Unallocated gold is a claim on The Bank of Nova Scotia for the ounces entitlement to a specific quantity of gold bullion.

And finally, this:

RSP Gold Certificates sold through Scotia McLeod are allocated, while all other non-registered certificates are unallocated

This means that the Bank of Nova Scotia likely sells a great deal more gold certificates than the physical gold that they have to back it up, because they only hold allocated gold if the certificates are bought within an RRSP plan at their Scotia McLeod brokerage.  The rest is just paper.

The idea, therefore, that there is far more gold paper than there is physical gold is not at all far fetched.  This was exactly the point of a previous post that suggests that gold should be worth $56,000.  But because there is many more times more paper gold than physical gold, the gold market is actually flooded with worthless papers.  The Bank of Nova Scotia is not alone in this practice of selling unallocated gold.

The fractional reserve system of gold selling is a dangerous practice and it puts the buyer in a position of assuming the bank’s default risk.  If you put your money in a savings account, it is insured up to certain amount.  But it doesn’t seem that unallocated gold certificates are insured at all.  This website seems to give a pretty good explanation of unallocated gold certificates:  gold.bullionvault.com/How/UnallocatedGold