RBC’s $1.2 million leveraged notes on Gold Miners show too high of a cap given buffer size

By Emma Trincal

New York, March 27 – Royal Bank of Canada’s $1.2 million of 0% buffered enhanced return notes due March 25, 2026 linked to the VanEck Gold Miners ETF offer investors a generous cap but not enough downside protection, sources said, pointing to the high valuation of the underlying ETF, which recently benefited from bets on the Federal Reserve cutting interest rates.

If the ETF return is positive, the payout at maturity will be par plus 110% of the ETF return, subject to a maximum return of 64.6%. If the ETF declines by up to 15%, the payout will be par, according to a 424B2 filing with the Securities and Exchange Commission.

Otherwise, investors will lose 1% for every 1% that the ETF declines beyond 15%.

Downside risk

“This is one of those high risk/high reward deals,” said Mark Dueholm, chief fixed-income trader at Landolt Securities.

“A 15% buffer is not that much especially given how fast GDX is rallying right now,” he said.

The ETF, which is listed under the “GDX” ticker, is relatively flat for the year. But it has soared since the end of February.

Dueholm offered an explanation.

“The market thinks rates are going to be lower. Gold tends to do well in a low-rate environment since it doesn’t provide income.”

Gold prices hit an all-time high on Wednesday at $2,213.30 an ounce.

“This is the result of traders’ bets on the Fed cutting rates. But if rates don’t drop even though the market thinks they are, you could be at risk.

“Obviously the cap gives you a lot of upside. But you’re taking a gamble on this note,” he said.

High expectations

The typical fundamental factors, which are usually driving gold prices, did not seem to apply to the recent run, he noted.

“It’s a little weird. Typically, people buy gold as a hedge against turbulent economic times or when the market is down. But right now, the economy is strong, the stock market is up...Yet people are still buying gold.

“This is different,” he said.

As investors expect lower rates of return on fixed income, gold is viewed as relatively more appealing than when rates are high, he explained.

“Hopes for Fed rate cuts are fueling this gold rally,” he said.

From the end of last month to last week when the notes priced at $29.06 for the initial level, the ETF has jumped nearly 21%.

“I just think the timing is off. The price of gold and gold miners is through the roof. People always buy when things are going well, when they’re confident. They should have the opposite mentality,” said Dueholm.

Ambitious cap

Andrew Valentine Pool, main trader at Regatta Research & Money Management, suggested that the cap for the upside return may just be too high.

“GDX has had a lot of movement. But over the past three years, the share price has stayed in a $24 to $36 band. With the deal pricing at $29, it’s right in the middle of that range,” he said.

The 1.1 leverage multiple would bring the cap to a price of approximately $46, he noted.

“If I look at a five-year chart or even longer, I don’t see that $46 level very often. In fact, I see it only once in the summer of 2020 during the Covid pandemic.

“Unless gold miners are on a tear, it’s unlikely that you’ll reach this cap.

“This ETF has a pattern of making lower highs. Even during Covid when there was plenty of money in the system, it hit $46 but didn’t go beyond that,” he said.

Before 2020, the $46 top was last seen in early 2013.

Meanwhile, the buffer price is at $24.70, he noted.

Pool raised the question of the usefulness of a cap, which he believed was too high to be easily reached.

“We’ve seen the $24.70 buffer level hit in the fall of 2022. That was much more recent,” he said.

“There’s an imbalance in the structure.

“I would have preferred to see a 20% buffer. It’s not much better, but it’s better enough.

“This note is aiming too high and is not defensive enough.”

RBC Capital Markets, LLC is the agent.

The notes settled March 25.

The Cusip number is 78017FP56.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.