Scotia’s $20.63 million digital on SPDR S&P Metals & Mining offer wide buffer, potential boost

By Emma Trincal

New York, Jan. 20 – Bank of Nova Scotia’s $20.63 million of 0% digital notes due Feb. 14, 2024 linked to the SPDR S&P Metals & Mining ETF may allow investors to navigate the bear market unscathed due to a low buffer strike, which offers a “generous” protection with a potential double-digit return, said Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments.

If the ETF finishes at or above its 70% threshold level, the payout at maturity will be $1,125.90 per $1,000 principal amount of notes, according to a 424B2 filing with the Securities and Exchange Commission.

Otherwise, investors will lose 1.4286% for each 1% decline beyond 30%.

The underlying ETF trades on the NYSE Arca under the ticker “XME.”

“I’m not a fan of XME anymore but at least the -30% strike gives you a fair chance to collect the full amount,” said Kaplan.

“I was a heavy buyer of XME back in March 2020 when the fund was at a bottom. But it has gone up so much since then, it’s probably fully valued or close to fully valued.”

The fund closed at $55.94 on Friday, which is about four times its low of late March 2020.

“It’s no longer a bargain but it’s a lot less overpriced than the S&P,” he said.

Miners’ rally

Kaplan used to be bullish on gold miners as well. But the sector is no longer trading at a discount.

The VanEck Gold Miners ETF has jumped 50% from its September low, he noted.

“There is some overlap between the two funds. About 23% of XME consists of gold miners. They’ve rallied together,” he said.

One difference between gold and metals such as copper is how their respective prices move in relation with the overall equity market.

“Base metals are more correlated with the stock market than gold miners,” he said.

The recent run-up in the metals & mining ETF was a perfect example of momentum trading with no fundamentals driving the rally.

“The share price of XME has been going up for the same reason other sectors have been going up,” he said.

“Tech was beaten up. People lost money. Investors sold their tech shares because no one wants to keep losers.

“People are chasing new highs. When energy is up, they shift to energy. When mining stocks are up, they shift to mining. They want the big winners. That’s how markets get overbought and overvalued. That’s how bubbles develop.”

Avoiding the cliff

While bearish, Kaplan was confident the timeframe of the note would benefit the investors.

The VIX recently hitting a one-year low at 18.01 was an alarming signal of complacency, he said.

“We’ll get some form of panic-selling this year. I can see the VIX climbing much higher somewhere between 60 and 90.”

The last time the CBOE Volatility index or “VIX” reached those levels was during the pandemic-induced bear market of February-March 2020.

“When you get into that kind of panic, you also get a big rebound,” he said.

“That’s why I don’t think we’ll see the bottom of the bear market when the notes mature in February 2024. It takes tons of time to get there.”

He gave the example of the 2000-2002 bear market, which in some European countries lasted until the beginning of 2003.

“We’ll have a big drop in 2024. I think 2024 will be a horrible year. But you have a decent chance to avoid a 30% drop by the time you get to the maturity date,” he said.

“Even if we have a serious drop in the first half of 2023, the market should start to rebound in the second half of this year especially if panic intensifies the sell-off, clearing the way for a recovery.”

Deep buffer

The terms of the notes contributed to Kaplan’s optimistic outlook.

“I like the structure because it has a buffer. Thirty percent is a very generous amount of protection. Even if the ETF is down 30%, you’re going to get your return,” he said.

The product was not designed for bulls, not even for bears, he added.

“It’s agnostic. People buying this note really don’t know. They expect the market to drop but not more than 30%. Even if it does, they still get the benefit of the buffer. Their losses will be greatly limited even with the gearing,” he said.

The portfolio of the underlying fund consists of 34 mining companies across different metals.

“You’re getting a majority of big companies. It’s a slight negative because large-caps tend to be overpriced.

“But on the other hand, you have the benefit of liquidity. If there is panic-selling in the market, the risk of being forced to sell is mitigated,” he said.

Leading miners

The top ETF component was Cleveland-Cliffs Inc. with a 5.52% weight.

“Cleveland-Cliffs is one of the largest base metals companies in the world. They’ve been around for a very long time. Their stock is not cheap. But they’ve been through a lot of ups and downs and it’s a well-established name,” he said.

Alcoa Corp., the second top holding in the fund, has a 4.93% weight.

“Alcoa is another solid franchise. They’ve been around for decades. It’s a global leader in aluminum,” he said.

Freeport-McMoRan Inc. and Newmont Corp., respectively the fourth and fifth holdings, are international mining heavyweights as well.

Both are gold producers, but Freeport-McMoRan is more engaged in copper than gold mining, he noted.

“All of these are not fly-by-night companies. They’re getting something out of the ground and sell it. The natural resources they extract are then used to produce the components needed for different sectors, especially technology.

“The note is reasonably priced. Having a 30% cushion over that period of time is a good thing. There is always a risk to be caught up in the bear market. But I think you should be able to avoid that given the length of the trade,” he said.

Scotia Capital (USA) Inc. is the agent.

The notes settled on Thursday.

The Cusip number is 06417YDB2.

The fee is 0.95%.

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