Lehman links conditional range notes to gold; strategy hinges on volatility, adviser says

By Kenneth Lim

Boston, July 24 - Lehman Brothers Holdings Inc.'s conditional range notes linked to the price of gold offer investors a market-neutral way to gain exposure to the asset, an investment adviser said.

"It's an interesting product, more of a play on volatility in gold than on the actual prices," the adviser said.

Lehman links to gold prices

Lehman plans to price a series of fully principal-protected conditional range notes due Aug. 2, 2010 linked to the price of gold.

Interest is payable quarterly.

The notes will be subject to eight reference range periods, each a quarter long. For each period, the range upper boundary will be the price of gold on the starting day of that period plus at least $55. The lower boundary will equal the price minus at least $55. The exact boundary factor will be set at pricing.

If the price of gold stays within the reference range, the notes will make an interest payment of 10% for that period. If gold moves outside the range, the interest payment will be zero.

Volatility key to notes

The return on the notes depends on the volatility of gold prices, the investment adviser said.

"This is kind of a market-neutral range accrual kind of product. It doesn't matter whether gold prices are up or down," the adviser said. "The part that matters is the volatility of gold. $55 is roughly about 5% or 6% of where gold prices are right now, so that's the range you have to stay within."

The adviser said it is easier for investors to miss out on a coupon during a reference period the higher the price of gold.

"What's interesting is they used a fixed dollar amount for the boundaries," the adviser said. "So percentage-wise, the protection gets less the higher gold is. If gold goes up $50 every quarter, your $55 becomes less than 5%. So that's something to note. Obviously as an investor I think if they'd used a percentage it would have been better."

Investors could get a better deal by investing in shorter-term products and reinvesting them, the adviser said.

"I could buy a principal-protected note or even a partially principal-protected note linked to gold that returns 10% if gold stays within plus or minus 5%," the adviser said. "Then at the end of that I could reinvest whatever I have in a new note with a similar structure, and all the protection levels will be reset."

Investors could also underperform gold, the adviser said.

"Let's say gold goes up 4% one quarter and 7% another quarter," the adviser explained. "Then you'd find yourself underperforming because you've got 10% the first quarter but nothing in the second quarter."

Notes provide access to gold

The product could be interesting for investors who are looking to gain exposure to the price of gold, the adviser said.

"Gold is usually a hedge against the dollar, so investors can use this as an investment to complement their other investments," the adviser said. "As is often the case with structured products for gold, it's a very convenient and cost-effective way for investors to access gold without having to actually go trade in gold futures."

Recent movements in gold prices could also make the product interesting, the adviser said.

"Gold has been climbing for a long time, and it's come down a bit this week," the adviser said. "Maybe there's a bit of uncertainty about where gold is heading, and some investors might want to get a market-neutral kind of product."

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