Posts Tagged ‘bull market’

Should you leverage to the max in a long-run bull market?

Sunday, July 18th, 2010

Between 1970 and 1980, gold was in a bull market. In 1971, the average price of gold was around US$40. By January 1980, it hit US$850. So, the question is: Surely, it was a good idea to leverage as much as you can in the 1970s (assuming you knew that gold would be in a bull market)? Since gold prices multiplied by 21 times from 1971 to 1980, and if you leverage to the maximum at any time in the 1970s, you will become filthy rich by 1980 right?

Wrong!

If you leveraged say, 10:1 in December 1974, you will be likely to be financially wiped out by August 1976. Between that time, gold prices fell from US$195 to US$103- a correction of 47%. Then from August 1976, gold resumed its up-trend to the high of US$850.

The lesson here is clear. Even in the midst of a long-term bull-market, you can become bankrupt if you are highly leveraged and unlucky.

Next question to ask: What if a lot of people are highly leveraged at the same time, in the same asset class, believing that it is in a long-term bull market? We will turn the answer to this question to our readers.