Securities Fraud Lawyer Blog
Leveraged Silver Bullion Investments: Avoiding a Bad Bet
Leveraged silver bullion investments present an unacceptable risk reward choice for investors. Due to excessive costs, interest and fees, an investor is far more likely to lose his entire investment than to break even.
With the recent rise in gold prices, salesmen in an overlooked corner of the investment community have been busy dialing investors for dollars. The gold and silver bullion industry is largely unregulated by state or federal agencies. This regulatory blindspot has permitted the rise of boiler rooms using high pressure sales pitches to sell overpriced gold and silver bullion to unsuspecting investors.
The pitch is that the federal reserve is printing money, and therefore the dollar will lose its value relative to “real money” gold and silver. The fact that gold and silver have held their value over centuries compared to the loss of purchasing power of government issued currencies is the foundation for the sales pitch.
But leveraged silver bullion houses don’t sell a long term buy and hold strategy. They exist to persuade investors to take out loans (supplied by the firm or its affiliate) to purchase bullion. The pitch is that investors will double or triple their money when silver closes the gold/silver ratio, or make millions when silver returns to its 2011 high of $50 an ounce.
Leveraged silver bullion dealers aren’t registered investment advisors, and aren’t regulated by state or federal securities agencies. In fact, there is virtually no oversight on the business, and as a result, some of the most egregious sales practice violations occur in the industry.
Because they have no duty to “know their customer” make “suitable” investment recommendations or charge fair prices, investors get clobbered on commissions and fees. A typical markup on a common 1000 ounce good delivery silver bar is $2.00 – $2.50 an ounce. The cost to the firm is generally 25 cents an ounce or less. Because it is a liquid market, the leveraged silver bullion firm can place a phone call, and instantly book a riskless 800% profit.
Investors are kept in the dark about the actual cost to acquire the silver bullion. And, because they don’t receive a trade confirmation with a time and date stamp, there is no way for them to know where the market stood at the time the trade was executed. There is no transparency in the industry, which allows fraud to go unchecked.
Here is an example of how the use of leverage works in the leveraged silver bullion industry.
Suppose you have $100 to invest, and the price of silver is $8 per ounce and the commissions/markup/premium (“Commission”) charged by the firm is $2 per ounce. Under this scenario, you could acquire 10 ounces for $100, after paying commissions ($8 silver + $2 commission).
Now let’s say the firm offered to loan you $200 to buy more silver. Again, with silver at $8 and a commission of $2, you could acquire 20 more ounces. ($8 silver + $2 commission = $10. $200/$10 = 20 ounces.)
So, with a $100 investment you could buy and control 30 ounces of silver.
That is the pitch. But what is the reality?
The 30 ounces of silver cost you $60 in commissions at $2 per ounce.
Subtracting $60 from your initial $100 investment, this means that from day one, your account is down $60, or 60%. This is not theoretical; it is a real cost.
Because the $200 loan from the firm is not free, you will also owe interest on the $200 borrowed. Say 10% (In reality, more like 11.5%).
On $200, that means that over the course of the year, you will pay $20 in interest. There are also storage costs, say 1% for storing the $240 worth of silver (30 oz. @ $8/oz.).
So, what are the annual costs of this transaction:
Commissions: $60
Interest $10
Storage: $2.40
Total $72.40
Note: This doesn’t take into account the cost to liquidate, usually 50 cents/oz.
Using this strategy, in order to break even, your account would have to increase in value $72.40 (a 72.4% return) in a year just to break even.
How is that possible? If your 30 ounces of silver increased from $8 an ounce to $10 an ounce ($2 or 25%) your account would have increased $60 in value ($2 x 30 oz.). This isnt enough to break even.
If silver increases $3 an ounce from $8 to $11 or 37.5%, your account value would have increased $90 and you would now be ahead $17.60.
Assuming you wanted to sell, book your profit and stop paying 10% interest, you would pay a sales charge of 50 cents an ounce on your 30 ounces, costing you a total of $15.00, leaving you with a net gain of $2.60 on your $100 investment. $90 profit less $87.40 ($72.40 buy and hold charges + $15 sales charge = $87.40).
Therefore, in order for an investor to book a 2.6% return using the modest 2x leveraged silver bullion strategy, silver would have to increase 37.5% in a year, something that historically rarely happens. Over the past 50 years that has happened only 7 times or 14% of the time.
What this means is that investors are far more likely to lose money in a leveraged silver bullion investment strategy than they are to make money or even break even.
Conversely, what happens if silver declines during this same period of time? March, 2020 saw violent swings in the spot silver price. Those people with two, three or four times leveraged accounts saw their entire account value wiped out as the leveraged silver bullion dealers liquidated silver to protect their collateral.
Using our same example of $100 being used to acquire 10 ounces of silver, with an additional 20 ounces acquired with a $200 loan, how does our account fair in a down market?
After deducting commissions of $2/oz. on the 30 ounces, the net value of the account is $40. If silver declines $1.50 per ounce, to $6.50 (an 18.7% decline) the value of the collateral disappears, and the silver is sold to pay off the loan. Here’s an example:
Account value with silver at $8: $240 (30 oz. @ $8)
Loan amount: $200
Net account value: $40
Account value with silver at $6.50: $195 (30 oz. @6.50)
Loan amount $200
Net account value: ($5)
As is evident, with a 18.7% percent decline the entire account is wiped out, as the leveraged silver bullion house will sell the silver to protect its collateral.
The above examples don’t take into account that the account’s value is being eaten away every month by storage and interest charges, or that the firm factors in a sales charge at liquidation. With this in mind, the firm will likely liquidate the account long before the decline reaches 18.7%. It will liquidate to protect its interests with a 15% decline. Using current pricing, this means that if silver declined from $18 to $15.30, an account using 2X leverage would be wiped out. However, because some firms allow 3X leverage (or more), declines of 10% would be sufficient to wipe out the account’s value. That is the reality for most victims of this unscrupulous industry.
To sum up: In order to earn a modest 2.6% return with a leveraged silver bullion strategy using 2X leverage, the price of silver needs to increase 37.5% in a single year. Contrast that with the fact that if silver declines 18% during that same time, the entire account will be wiped out. And, the longer an investor holds the leveraged position, the more interest and storage costs eat into any return. Clearly the risk return analysis is not a positive one for the investor.
Compare that with how the leveraged silver bullion firm makes out: seventy five cents of every dollar deposited is consumed by commissions ($2 on the buy, .5 on the sale), while ten cents or more of every dollar goes to pay interest for the loan. Add storage at 1%, and it’s clear that virtually every penny deposited into a leveraged silver bullion strategy is consumed by fees and costs.
Given the high pressure sales tactics, and unconscionable fees, investors would be well advised to stay far away from leveraged silver bullion firms that operate more like criminal enterprises than legitimate investment firms.