Bank of America’s Accelerated Return Notes linked to gold offer potential to outperform

By Emma Trincal

New York, March 11 – Bank of America Corp.’s 0% Accelerated Return Notes due April 2017 linked to the gold spot price are designed for investors who are moderately bullish on gold and want to maximize their gains via a high leverage factor, sources said.

The payout at maturity will be par plus 300% of any gain in the gold spot price, subject to a cap of 17% to 21% that will be set at pricing. Investors will be exposed to any losses, according to a 424B2 filing with the Securities and Exchange Commission.

Investors who agree to see their two-year return capped at about 20% are not overly bullish, sources said.

“If they were, they would invest directly in gold futures,” a market participant said.

Moderate expectations

Assuming a cap at the mid-point of the range, or 19%, the spot price of gold would not need to increase by more than 3% a year in order for investors to achieve their optimal return, which is about 9% per year with compounding.

“This is for someone who thinks that gold can be marginally up over the next two years,” said Scott Cramer, financial adviser at Cramer & Rauchegger, Inc.

“For every dollar they risk, they can get three times the return. Assuming that gold prices are not going to increase by more than 21%, it’s a way to outperform the underlying asset. You just don’t see gold going through the roof. That’s the view.”

Questionable hedge

Gold has been a volatile asset class, trading mostly downward since its September 2011 high at $1,885 an ounce. The spot price since then has dropped nearly 40% to $1,154.

“My personal opinion: I don’t think it’s a good bet,” continued Cramer.

“Gold is supposed to be a good hedge against inflation. But it remains to be proven. People say that it’s a good inflation hedge, but that’s not good enough for me.

“When the U.S. was under the gold standard, as inflation went up, the value of gold was worthy. In that context, yes. But we’re no longer on the gold standard.

“In addition, gold is not a resource. It’s not used to produce electronics. It doesn’t have any intrinsic value.

“If the world comes to an end, it will have value in theory. Again, that’s common knowledge, but I’m not convinced that it’s true. Food and energy would be much more in demand in an Armageddon scenario.

“People used to buy gold as an insurance. They thought that with all the Fed printing we would have an inflation problem. They were proven wrong. We didn’t have inflation. And even if we did, gold would not necessarily be a good hedge against it.

“What drove gold prices higher after the financial crisis was more marketing than anything.

“Today the U.S. economy is the best house in a bad neighborhood. Nobody at this point believes that the U.S. economy is going to collapse. Instead people are buying Treasuries in a flight to quality. They’re not buying gold.”

Dollar gold arbitrage

The market participant said that gold bulls could reemerge if investor confidence in the dollar were to recede. This would be a reverse of today’s bullishness on the greenback, he added.

“The U.S. dollar has climbed a lot lately. More people use the dollar as a safe heaven than they use gold,” he said.

“But if the dollar becomes too expensive, we could see a renewed interest in gold or in the Swiss franc as instruments of choice for safety.”

He noticed that the amount of leverage in the notes is attractive given the underlying asset’s volatility.

“Gold options are very sensitive to changes in volatility right now. It makes it a bit harder to structure leverage because the higher the volatility, the higher the price of the call options,” he said.

The notes will price in March and settle in April.

BofA Merrill Lynch is the agent.

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