The AI Trade Meets Its Oldest Enemy: Leverage

Key Takeaways:

• Artificial intelligence does not need to fail for the AI trade to unwind. Leverage can do that on its own.
• Concentrated, borrowed positions can force selling even when the long-term thesis is intact.
• Falling collateral can turn a correction into a liquidation spiral across crowded trades.
• Assets that carry no counterparty risk behave differently when leverage forces the exits.

Leverage, not AI, is the risk in focus

Artificial intelligence does not need to fail for the AI trade to unwind. Investors only need to combine extreme confidence, concentrated positions and too much borrowed money.

That appears to be the lesson emerging from Situational Awareness, the hedge fund founded by former OpenAI researcher Leopold Aschenbrenner. After generating strong returns from leveraged bets on companies connected to the AI boom, the fund reportedly sold most of its US$16 billion public share portfolio to Citadel following heavy losses.

The portfolio included chipmakers and AI infrastructure companies such as SanDisk, SK Hynix, Bloom Energy and Nebius. These were among the market's stronger performers while enthusiasm for AI investment continued to grow. Once the trade reversed, however, leverage turned falling prices into a threat to the fund itself.

How forced selling works

Situational Awareness was reportedly placed under pressure to either raise more capital or reduce its positions. Citadel ultimately purchased the portion of the portfolio financed through loans from prime brokers, allowing the assets to be transferred without causing greater disruption through open-market selling.

This demonstrates the fundamental danger of leverage. An investor who owns an asset outright can generally choose to hold through a decline. A leveraged investor may be forced to sell, even if the original long-term thesis remains intact.

As prices fall, the collateral supporting a loan becomes less valuable. Lenders can demand additional capital or require positions to be reduced. Selling then places further pressure on prices, weakening the collateral of other investors holding similar assets.

This is how a correction can become a liquidation spiral.

Why crowded trades amplify the risk

The risk is greatest when an investment theme becomes crowded. The AI trade now extends well beyond a handful of technology companies. It includes semiconductor manufacturers, memory producers, data centres, electricity providers, cooling systems and businesses building the infrastructure required to support enormous computing demand.

These companies may operate in different industries, but many depend on the same underlying assumption: that AI investment will continue expanding rapidly and eventually produce returns sufficient to justify the spending.

Reuters reported that global hedge funds experienced one of their largest monthly drawdowns on record during the recent selloff, with Asia-focused fundamental long-short funds losing an average of 18.6 per cent through 28 July. Several major Situational Awareness holdings then rebounded once traders concluded that the forced selling was largely complete.

What it means for investors

Leverage-driven selloffs are a reminder of a distinction that matters for any portfolio: the difference between assets you own outright and positions you are financing. When borrowed money forces the exits, even sound long-term theses can be sold down at the worst possible moment.

Physical precious metals sit at the other end of that spectrum. Gold and silver held outright carry no margin call, no lender and no counterparty who can compel a sale. That does not make them immune to price swings, but it does mean the decision to hold through a decline stays with the investor rather than a prime broker.

For investors thinking about how a portfolio might hold up when crowded trades unwind, Ainslie Bullion offers a full range of physical gold and silver bullion.

This article is general information only and does not constitute financial advice. Past performance is not indicative of future results. Always conduct your own research or consult a licensed financial adviser before making investment decisions.