Is Borrowing on Bullion Dangerous? | February 19, 2013 | By Patrick A. Heller

 (This article was originally printed in Numismatic News.)

bullionOne scam perpetrated by some marketers of rare coins and precious metals is to pressure customers to leverage their purchases in hopes of magnifying potential profits. I have heard a number of horror stories over the years of people who have lost their entire investment because prices of their holdings declined, leading their accounts to be closed because they could not make timely payment for margin calls.

Leverage accounts not only magnify the potential profits that might be realized. They also increase the risk of loss, which many people have found out to their financial dismay. We helped people at the end of last week who had to raise immediate cash to meet margin calls because their holdings of leveraged gold and silver fell in value.

A dealer can only make so much profit on a $50,000 sale.

If, instead, the dealer can persuade the customer to pay $50,000 and borrow another $200,000 to make a total purchase of $250,000, the dealer can then make five times the profit margin. The dealer can also probably make an additional profit from the interest on the loan. This explains why some dealers give an extremely hard sell to establish a leveraged account. While portraying a leveraged purchase as an opportunity to make greater profits, dealers may ignore or downplay the costs and risks associated with such transactions.

Naturally, those who make leveraged purchases do not get possession of their assets. Those are held as collateral to secure repayment of the loan. Some crooks have charged people for leveraged purchases without ever bothering to acquire the assets allegedly being held as collateral. The risk of malfeasance by the dealer in such transactions is just one more reason to avoid or be extremely careful in conducting a leveraged purchase.

What purchasers tend to ignore is that the prices of rare coins and precious metals are volatile. If the price dips 10 percent temporarily, a $250,000 purchase drops to $225,000 of collateral. If the buyer is required to have assets equal to 125 percent of the loan, the buyer would have to come up with an immediate additional $25,000 or face liquidation at low prices of more than 50 percent of the assets. (Terms vary among different companies, so understand that this is a generic example.)

If the buyer fails to meet the margin call, it is possible that the entire position may be closed out, with the purchaser getting back only the $25,000 less interest and transaction costs. That means the buyer would be facing a potential loss possibly exceeding 50 percent of the investment even if prices rebound and later rise above the entry point.

Prices of gold and silver rose almost continually from late 1979 to about Jan. 19, 1980. But, before it began a string of daily gains, the price of silver dropped about 5 percent one day. We have one customer who told us he had a leveraged silver commodity position in 1979. When he got a margin call on the day of the 5 percent drop, he was unable to come up with the funds. As a result, his position was closed. In the customer’s mind, that one day drop cost him a potential profit of $250,000.

For almost every buyer of rare coins and precious metals, I recommend not using leverage. For gold and silver investments, you want to have direct custody of your “insurance” holdings. You definitely do not want them held by a third party as collateral for a loan. Leveraged transactions are only for those who can financially afford the risks and are using only funds that they can afford to lose.

I know several rare coin and precious metals dealers that offer the option to leverage purchases for their customers as one of a menu of services they provide. They do so in a straightforward and helpful manner. However, if you contact a dealer to make a purchase where the sales representative immediately starts pushing you to leverage your transaction, your safest option is probably to hang up and not contact that company again.