Deutsche Bank's six-month notes linked to Norwegian krone are a bet on eurozone crisis, oil

By Emma Trincal

New York, July 19 - Deutsche Bank AG, London Branch's upcoming 0% capped notes due Jan. 26, 2012 linked to the performance of the Norwegian krone relative to the dollar are designed for investors mildly bullish on the krone who do not anticipate a systemic crisis in the eurozone, sources said.

Additionally, one of those sources noted, the trade is a bullish bet on oil.

If the krone strengthens or remains unchanged relative to the dollar, the payout at maturity will be par plus the currency return, subject to a minimum return of 7.5% and a maximum return of 8%, according to an FWP filing with the Securities and Exchange Commission.

If the krone weakens relative to the dollar by 10% or less, the payout will be par.

If the krone weakens by more than 10%, investors will participate fully in the negative currency performance.

Euro crisis

"The outlook of the krone going higher or not will depend on how the European crisis gets resolved," said Mark McCormick, currency strategist at Brown Brothers Harriman.

McCormick said that the eurozone crisis could worsen within the next six months, which would have a negative impact on the krone.

"One month ago, I did not think that the European crisis could be systemic in nature. But since the contagion has now spread to Italy and Spain, this is becoming more of a global issue," he said.

"We're getting to a point where there's going to be a binary outcome," he said. Depending on the outcome, the notes could represent a source of gains or losses.

"Either the eurozone countries find a solution to limit the contagion. This would lead to a bullish scenario for the krone," he said.

"Or the problem doesn't get resolved and we get a potential break of the eurozone. In that case, the krone would be hardly hit. The euro would fall significantly relative to the dollar, and the relation of the krone to the euro would weaken significantly more."

Systemic shock

Norway is not a state-member of the European Union. But its currency is very sensitive to the moves of the euro relative to the dollar, McCormick explained.

"The krone being in the G10 scope is a high-beta currency. If there was a sellout, the krone would sell out harder than other currencies, including currencies in the eurozone," he said.

The vulnerability of the krone would also be the result of the potential systemic shock a disruption of the eurozone would create, he said.

In turn, any double-dip scenario would put pressure on the krone because the Norwegian currency can be traded as a proxy for oil.

Oil is Norway's main export commodity and represents a large part of the country's GDP, he said.

"The price of the Norwegian currency is very sensitive to the price of risky assets. If you had an equity or commodities sell-off, the krone, which is volatile, would fall more than the euro," he said.

Over the past six months, the standard deviation of the krone has moved more than 11% on the downside, said McCormick.

"Certainly a 10% decline is possible in that timeframe," he said.

Some new developments around the European debt crisis should be known Thursday, McCormick said, when the eurozone heads of state hold a summit to put together a second bailout package for Greece.

The notes are set to price the next day, Friday.

Mildly bullish

Lee Kramer, president of Capital Management Analytics, agreed that a very negative scenario in Europe would make the product risky. But he said that the chances for a serious crisis remain limited.

"There could be a tipping point if there was a real crisis and the euro collapsed. You would have an overall sell-off. But I'm not that bearish," he said.

"I'm bullish on the Norwegian currency, and this is the type of structure that I would consider."

For Kramer, the repercussions of the uncertainty in the eurozone could be positive for countries such as Norway that are not part of the eurozone as long as the crisis is contained.

"If the euro continues to weaken but doesn't blow up into a crisis, then I think the Norwegian currency would benefit," he said.

Good upside

The structure of the notes offers a potential upside limited to a range of 7.5% to 8%, leaving no room for participation to the upside outside of that range.

"It's a narrow range and it almost makes it like a digital note. It's a little peculiar. For practical purposes, I would see it as a digital note," Kramer said.

Regardless of the payout structure, the minimum contingent payment is attractive, he added.

"Getting 7.5% for six months, or 15% annualized, that's a good upside," he said.

Bet on oil

Kramer said that the notes also expressed a view on energy.

"Norway is a very big oil exporter, so it's also a bet on oil," he said.

"Despite a dollar rally a couple of months ago, oil has strengthened and should continue to do so."

Norway is the seventh largest exporter of oil in the world.

Kramer said that he is comfortable with the level of protection as well.

"This kind of structure is attractive. It's mildly bullish. And you're not taking a tremendous risk with it," he said.

"You'll only lose if the currency drops by 10%, and that's a pretty big move in six months.

"If you look at the chart, the krone has appreciated by 10% since the beginning of the year.

"So there would be a lot of support for that currency if it was to drop by 10%."

The notes (Cusip: 2515A1AA9) are expected to settle July 27.

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