HSBC’s leveraged notes on VanEck Vectors Gold seen as well-positioned for early stage rally

By Emma Trincal

New York, March 29 – HSBC USA Inc.’s 0% Accelerated Return Notes due May 2020 linked to the VanEck Vectors Gold Miners ETF come at a good time as gold is about to rebound from recent lows, said contrarian investor Steven Jon Kaplan, founder and portfolio manager of TrueContrarian Investments. His market outlook, which is bearish on U.S. stocks and bullish on emerging markets, reinforces his stance.

The payout at maturity will be par plus 300% of any gain in the fund, subject to a maximum return that is expected to be 20% to 24%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will lose 1% for each 1% decline in the fund from its initial level.

Time of entry

Kaplan tends to avoid the 2020-time horizon – an election year – but mainly for U.S. equities. While the VanEck Vectors Gold Miners ETF (listed under the ticker “GDX”) is an equity fund, it is closely related to the price of gold, which makes this portfolio manager more comfortable with the maturity date. In addition, the notes will mature six months ahead of the elections.

“We don’t know exactly when we’ll have a market downturn with a recession. It could be in 10 months, in 14 months or maybe later. Certainly, the elections next year will bring more volatility,” he said.

“The note could also mature prior to big market moves. Regardless, I think it’s good timing. Gold is still relatively cheap. It’s been going up a little since a recent drop. But it’s still trading at a good bargain price.”

Recovery mode

He looked at the chart pointing to a recent rebound observed since September, which has decreased in momentum since February. In his view, the fund can rally further.

The ETF was trading at around $22.50 per share late afternoon on Friday.

“We’ve been down a bit from the $23.70 most recent high of February and we’re still fairly close to that level. But there were higher highs in 2016, 2013 or 2011 that can be revisited,” he said.

Especially if the long bullish bull cycle has now reached its end, which is one of Kaplan’s convictions.

Bear factor

“GDX will do very well if we are already in a bear market as I believe we are,” he said.

The price of the Russell 2000 index and how it compares with the trajectory of the S&P 500 index was in his view one of the most reliable indicators of the downtrend.

“The Russell 2000 hit an all-time high on Aug. 31, at which point it started to go down. It bottomed in December and has gone up a little until February but it failed to get back to its previous high of last summer. Since then, it has been dropping, making lower highs,” he said.

“In addition, the Russell continues to underperform the S&P, a classic signal of a bear market.”

Based on past bear markets, he said the outlook for gold was upbeat.

“During a bear market, people switch to other kinds of assets, especially if they perceive them as being safer,” he said.

That’s what happened during the dot.com crash, he said.

The VanEck Vectors Gold Miners ETF did not exist during the 2000-02 bear market. But its equivalent, the NYSE Arca Gold BUGS index, saw its level quadruple between November 2000 and June 2002, he noted.

During the last bear market, the share price of the VanEck Vectors Gold Miners ETF skyrocketed too. It increased four-fold as well between October 2008 and August 2011.

“When you get into a bear market, gold mining stocks do very well,” he said.

Global bid on gold

Another factor likely to push up the share price of the ETF is the rising demand from countries that heavily bid on gold, most often for cultural reasons, he noted.

“China, India, Malaysia are traditionally big buyers of gold. India buys a lot of gold for jewelry. Demand from those countries declined last summer when their local currencies fell against the dollar. Last summer, the Indian rupee fell to an all-time low against the U.S. dollar, making it difficult for this country to buy gold. When the currency is weak, you’re going to cut back on gold before you cut back on food or energy,” he said.

Emerging markets recovery

The correlation between gold and emerging markets was fairly visible last year.

On Sept. 11, 2018, the gold miner ETF hit a two-and-a-half year low and began to rebound from that point. Also, in September, emerging markets, which endured a bear market throughout the entire year, started to recover.

“When emerging markets hit their worst point back in September and began to bounce back, gold reverted as well,” he said.

“That’s when we started to see an influx of money moving into gold. The currencies of most emerging markets began to appreciate again against the dollar. It was an important trend reversal.”

With the strengthening of those countries’ currencies against the U.S. dollar, the global bid on gold reappeared.

“The wealth effect took over and people started to buy gold again,” he said.

The impact of China, India and other big gold-holding countries is significant, he said.

“Demand from those countries provides a level of physical support when prices are heading down.”

A complement

The notes are not designed for a very aggressively bullish bet. Yet, Kaplan said he liked the product.

The 20% to 24% cap over 14 months may still accommodate a bullish outlook albeit not a very bullish one.

Kaplan understood that fact but still saw the structure as a good opportunity to play a rebound in the asset class on the short term.

“I’m very bullish. But I see this product as a complement for a bullish strategy,” he said.

“If the ETF is not up as much as I hope, the note will magnify the small return.

“It can be used to balance a portfolio that already owns the actual shares.”

Given Kaplan’s positive outlook on gold miners, the full downside exposure was not seen as a major drawdown.

“It’s part of the tradeoff. They could have given you less on the upside. Personally, I more comfortable with the bullish structure they put in place,” he said.

“The fund has been rallying since September but should go up a lot more. We’re still at the early stages of a bull market for gold. I don’t think there’s that much downside risk when you get in that early on.

“It seems like a note worth looking into. It could balance a more traditional long position.

BofA Merrill Lynch is the underwriter.

The notes will settle in April.

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