The use of various financial instruments or borrowed capital to increase the potential return of an investment. Investors leverage their investments, expecting the profits made to be greater than the cost of borrowing.

How to Leverage Gold Investments

There are various ways to use leverage in gold trading and investment. Individuals may leverage their exposure to gold investments by borrowing from their broker. They may also use securities like options and futures contracts, which are bets between market participants where the principal is borrowed at t-bill rates. Another - one easier to carry out - idea is to use the leveraged ETFs and ETNs. 

Moreover, hedge funds may leverage their assets by financing a portion of their portfolios with the cash proceeds from the short sale of other positions.

Leverage Risk - Gold Stock Example

However, one must remember that with increased leverage comes increased risk. It can magnify profits and losses. For instance, if you have $5,000 cash in a margin-approved brokerage account, you could buy up to $10,000 worth of marginable gold stock. You would pay 50% of the purchase price and your brokerage firm would front the other 50%. So, you have $10,000 in buying power. Leverage can be very profitable when your gold stocks are going up. In this case, it doubles your profit. However, the multiplying effect works the other way as well. Especially when investor uses derivatives such as futures contracts or options to enhance return on value without increasing investment.

Leverage increases your level of market risk. Your downside may not be limited to the collateral value in your gold investment account. Your brokerage firm may initiate the sale of any securities in your account to meet the so called margin call, and it may also increase its maintenance margin requirements at any time, based on the current volatility of a given market.

Used wisely and prudently, a leverage can be a valuable tool in the right circumstances. Futures contracts and other derivatives allow considerable flexibility in varying leverage, as traders are not obligated to take advantage of the maximum allowable. Concluding, it is best to use enough leverage to be able to generate above average returns without using so much leverage that exposes to excessive risk.

For traders, the best solutions are usually (consulting an investment advisor is necessary to definitely choose the optimal investment vehicles) those that provide high liquidity and offer leverage:

  • Exchange Traded Funds (ETF) and Exchange Traded Notes (ETN) – for beginning investors.
  • Futures and options – for advanced investors.

Leveraged Gold ETF / ETN

The first gold ETF in the world, Gold Bullion Securities, was created in March 2003. Its shares are quoted on the Australian Stock Exchange in Sydney. At the time of its inception one share corresponded to 0.1 troy ounce of gold. As of now (March 2012) the biggest gold ETF in the world is SPDR Gold Shares (GLD), which is also the second biggest ETF in the world in terms of asset value.

A lot of ETFs can be found on the New York Stock Exchange (NYSE), London Stock Exchange (LSE) or Toronto Stock Exchange (TSX).

Exchange traded notes are funds that combine the features of ETFs and bonds. Like bonds they have a maturity date and their value depends on the value of a given market index or precious metal (e.g. gold) and the credit worthiness of their issuer. They are distinguished from exchange traded funds by the fact that they do not own gold in physical form – they usually invest money entrusted to them in futures contracts. ETNs are only debt instruments – a promise to pay a specified amount of money, dependent on the performance of a connected index or precious metal, on the day of maturity.

They are a relatively new financial instrument. The first exchange traded note in the world was a fund named iPath, created by Barclays. It was launched on June 12th 2006. Soon after, ETNs created by Bear Stearns and Goldman Sachs were introduced and then ETNs created by other banks, including UBS, Morgan Stanley or Lehman Brothers. Two years after the launch of iPath there were already 56 ETNs issued by 9 banks.

There are many ETNs on the market that follow gold. They are offered by many banks around the world including Barclays, Goldman Sachs, Swedish Export Credit Corp., BNP Paribas, Deutsche Bank, UBS, Morgan Stanley and Credit Suisse. They can also be bought or sold on stock exchanges. The biggest number of exchange traded notes is quoted on the New York Stock Exchange (NYSE).

Deutsche Bank, for example, has the following ETNs on offer:

DGZ – 100% anti-gold, moves in the opposite direction of gold. Purchase if you want to profit from gold’s decline (not recommended for most investors, as this means taking positions against the main trend).

DZZ, GLL – like above, but these funds involve double leverage. In other words, if gold gains 1%, this fund loses 2%.

DGP – 100% gold, double gold. Moves in the same direction as gold, but involves double leverage. If gold gains 1%, the fund gains 2%.

Sunshine Profits' Gold & Silver ETF Ranking allows you to pick ETFs and ETNs for your specific needs

Leveraged Silver ETF / ETN

Leveraged Silver ETFs work the same as leveraged gold ETFs. They include leveraged double (2x) and triple (3x) long bull and short bear ETFs.

Leveraged Gold Stock ETF / ETN

The gold stocks ETFs and ETNs carry high risk, but can provide an extra reward. By investing in individual miners, you are exposed to market, sector and individual company risk. ETF funds provide diversification so the individual, company-specific risk is greatly lowered. On the other hand by using an ETF instead of individual mining stocks, one resigns from the benefits and potentially additional profits that could be gained thanks to employing specific rebalancing techniques.

Leveraged Junior ETF / ETN

These products carry the highest risk. By investing in individual junior miners or explorers, you are exposed to market, sector and company volatility. Of all of the gold and silver mining related stocks, these stocks are the most volatile on a daily and weekly basis.