Buying Gold On Leverage Versus Physical Ownership

When it comes to investing in gold and silver, depending on which advertisement you respond to, the sales person will typically push investors towards the product they can make the most money. This tactic is true no matter what industry is involved. Whether it is an insurance salesmen pushing high commission annuities or the financial adivsor pushing illiquid REITs that pay a hefty 6% commission, there is an incentive for the sales person to try and make as much money as possible.

Of course this isn’t always the case, but one should be aware of what an advisor makes in commissions and what alternative investments may better suit the investor.

The 3 Types Of Gold Dealers

Gold dealer salesmen come in three types. They either recommend investors buy rare or semi-numismatic coins, bullion only coins and bars, or leveraged investments where you can finance your gold investment with as little as 20% down.

I’ve already addressed gold dealers who sell rare or semi-numismatic coins in several articles. But buyers of gold and silver need to be aware of the risks involved in buying gold or silver on leverage. Unfortunately for most, they don’t find out about these risks until it’s too late.

Buying Gold or Silver On Leverage

There are numerous companies that advertise on television who sell bullion gold and silver, but once the potential investor calls in, instead of buying physical gold or silver, they are pushed to take their allocation and use it as a down payment on acquiring more. This way, the investor can reap the rewards of owning up to 5 times their original allocation.

It works like this. An investor has $20,000 they wish to put into gold. The gold dealer sales person says “how would you like to own 5 times as much gold?” The investor is already interested in buying gold, so it’s an easy sale to convince them they can earn 5 times as much on their investment. After-all, gold has gone up in price every year for the last 10 years, how can you lose?

Instead of owning $20,000 worth of gold, in this example, the investor would own $100,000 worth of gold. They then would have to pay interest to the gold dealer at the going rate of 5% or possibly higher, depending on the dealer, on the difference ($80,000 x 5%). As long as gold goes up in price higher than the 5% interest expense, the investor is ahead of the game.

There Are Risks To Leveraging Gold and Silver Investments

Even though the price of gold ended 2008, year over year higher, there were many who bought gold in March of 2008 at the height of the current gold cycle and saw their investment dwindle to nothing. You see, if the price of gold falls by 20% in a certain time-frame, it can wipe out the entire investment of $20,000. And you still may owe for the interest for the time you were fully invested.

In our example, if you had $100,000 worth of gold purchased in March of 2008, and the price fell 20%, you would have a loss of $20,000, your original investment. You would then have to come up with more money to put into your account to keep your investment, or be forced to take your losses.

If you put more money in, there is always the chance gold could keep falling and one must remember, you are losing money at 5 times the rate of just an outright purchase of gold. Gold could also rebound and you may turn out ok over a longer time held. But one should know which type of investor they are before getting into this predicament.

The Physical Gold Alternative Investment

In March of 2008, the investor who bought $20,000 of gold at $1,000 an ounce would now be sitting on $6,000 of profit for a total liquid investment of $26,000 at the current price of approximately $1,300 an ounce. They could have even locked in profit at a higher price when an ounce of gold was selling over $1,400.

One must understand that gold is an overall good investment and hedge or insurance against U.S. dollar risk and the government’s out of control spending. But when they buy gold or silver on leverage, it is a risk that only those who are well capitalized should be taking.

It’s the same story we’ve heard year after year with the tortoise and the hare. One has to know if they are a conservative or aggressive investor. Only aggressive investors should be leveraging their gold and silver investment. But one can’t do this forever. In the end, the tortoise won the race.

The Current Pullback In the Price of Gold and Silver Will See Leveraged Investors Complaints Rise

As the current price of gold and silver takes a breather, you’ll see the number of complaints rise against those who sold leveraged investments. There will be a local news story about a little old lady who lost her savings because of this. This little old lady should have never been sold this type of investment to begin with, let alone put all she has into such an investment as gold.

Greed Goes Both Ways

There will always be the greed of the commission hungry gold dealer sales person in putting clients in unsuitable assets. The same goes for insurance and financial advisors as noted above. If one is educated before investing in gold and silver, they will know what risks they could or should take.
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About Doug Eberhardt

Doug Eberhardt is a 28 year financial services veteran and precious metals broker selling gold and silver at 1% over wholesale cost. Doug has written a book to help investors understand how gold and silver fit into a diversified portfolio, how to buy gold and silver, and what metals to buy. The book; “Buy Gold and Silver Safely” is available by clicking here Contact phone number for Buy Gold and Silver Safely is 888-604-6534