Goldman Sachs, Bank of America plan capped, leveraged notes on gold for moderate bulls

By Emma Trincal

New York, Dec. 1 - Firms are readying capped, leveraged notes tied to the price of gold in an effort to appeal to moderately bullish investors who believe that the gold rally is not over yet but foresee a more subdued pace of growth in the price of the precious metal.

Two deals

Goldman Sachs Group, Inc. plans to price 0% commodity-linked notes due Dec. 14, 2012 tied to the price of gold, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus 163% of any increase in the price of gold, subject to a maximum payment of $1,163.00 per $1,000 principal amount of notes.

Investors will receive par if the price of gold falls by up to 15% and will lose 1.1765% for every 1% drop in the price beyond 15%.

Separately, Bank of America Corp. plans to price 0% Capped Leveraged Index Return Notes due March 2013 linked to the gold spot price, according to an FWP filing with the Securities and Exchange Commission.

The payout at maturity will be par of $10 plus 200% of any gain in the gold spot price, subject to a maximum return of 18% to 22%. The exact participation rate will be determined at pricing.

Investors will receive par if the gold spot price falls by up to 10% and will be exposed to any losses beyond 10%.

Both products are for gold bulls but not aggressive bulls, sources said.

"These two notes would be for somebody who wants exposure to gold but who isn't sure where it's going," said Steve Doucette, financial adviser at Proctor Financial.

"You're moderately bullish; you still think gold is going up but not that much, so you're looking for that leveraged upside with a little bit of protection on the downside."

Bearish view

Doucette said that many reasons drive investors to buy gold. However, he would not consider the notes because he believes that the price of gold is likely to see a correction after years of a sustained rally.

"I'm not bullish on gold. I believe in reversion to the mean regardless of the asset class," he said.

"Gold has been on a tear for years.

"Anything that does go up is going to have to come back at some point. Where is the mean, that's the question," he said.

While the notes provide some downside protection, Doucette said that he found the products too risky given that "gold is more likely to adjust on the downside than it is to adjust on the upside."

He said that people have been buying gold as an inflation hedge or more recently as a protection against the European debt crisis.

Recently, "gold has been behaving like equity, and that's a problem," he noted.

"But regardless of those reasons, my perspective is simple: an asset class that has been outperforming for five years, at some point will go through a correction. Look at real estate in 2008!

"Gold's performance has been amazing. It rose by 35% a year in the past five years. It's just not sustainable," he said.

Gold's spot price increased by 170% since Dec. 1, 2006 when it priced at $646 an ounce to $1,740 today.

The 170% price appreciation in the past five years represents an annualized rate of return of 34%.

Bullish view

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said that he liked the underlying view of the notes since he is bullish on gold.

But he would shy away from leveraged products in general.

"We have a bullish outlook for gold in 2012. People are looking for relatively secure investments and there is still uncertainty in the equity markets, so as a result, gold remains an attractive asset class," he said.

Medeiros noted that gold and equity have been moving in synch.

"There has been an increase correlation between gold and equities recently, but all asset classes are having high correlations. Things eventually will go back to historical correlation levels," he said.

In the meantime, Medeiros is playing on the positive correlation saying that he is bullish both on gold and equities.

"We think there will be a slight increase in equities as well," he said.

Two different buffers

One of the main structural differences between the two products is the buffers, noted the financial advisers.

With the Goldman Sachs deal, investors are protected up to a 15% decline, but incur some leveraged downside beyond that point.

According to Goldman Sachs' prospectus for instance, if the final price of gold declined by 75% from its initial level, investors would lose 70.59% of their principal.

With the Bank of America notes featuring a 10% buffer, a similar 75% decline in gold price would translate into a 65% loss of principal, which is less.

Medeiros said that he would prefer the Bank of America product over the Goldman Sachs notes.

"The [Bank of America] deal would give more opportunity on the upside and is more attractive on the downside too," he said.

"While their 10% buffer is smaller than the 15% offered by Goldman, at least I just have a one for one loss beyond that.

"The 5% difference between the two is fairly small.

"Because of the dramatic swings in this market, this 5% difference could be hit rather quickly and I wouldn't want to compound the downside with the leverage," he said.

Goldman Sachs' notes (Cusip: 38143UH87) are expected to settle Dec. 9.

Goldman Sachs & Co. will be the underwriter, and J.P. Morgan Securities LLC will be the agent.

Bank of America's notes are expected to price and settle in January.

Bank of America Merrill Lynch will be the agent.

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