Barclays' digital notes tied to Gold Miners offer solid structure, but underlying bet is risky

By Emma Trincal

New York, May 14 - Barclays Bank plc's 0% buffered SuperTrack digital notes due Nov. 29, 2013 linked to the Market Vectors Gold Miners exchange-traded fund offer attractive terms for investors who want to express a bullish view on gold, sources said, although the underlying equity fund introduces additional risks.

If the Market Vectors Gold Miners ETF finishes at or above its initial share price, the payout at maturity will be par plus the digital return of 16.25% to 20.25%, according to a 424B2 filing with the Securities and Exchange Commission. The exact digital return will be set at pricing.

Investors will receive par if the shares fall by up to 20% and will lose 1% for every 1% that they decline beyond 20%.

"It sounds like a pretty plain-vanilla digital return note with a buffer," said Carl Kunhardt, wealth adviser at Quest Capital Management.

"But like all structured products, you have to go back to the underlying security."

The Market Vectors Gold Miners ETF, which trade under the NYSE Arca ticker symbol "GDX," invests at least 80% of its total assets in common stocks of gold mining companies. Its top three holdings are Barrick Gold Corp., Goldcorp Inc. and Newmont Mining Corp.

Bears need not apply

The notes are designed for investors who have a bullish view on gold.

"I don't invest in gold," Kunhardt said. "Since 2007, gold has taken a space shuttle ride. I don't think you can trend it out on 18 months. It's an asset class that purely runs on fear.

"It doesn't make sense to me to buy gold at this trajectory and at an unsustainable valuation simply because I'm afraid of the market.

"For a structured note it looks very reasonable. If you buy notes using a check list of attractive terms, you could [put a] check mark in every box."

Some of the "boxes" checked are the 20% buffer, the digital payout and the relatively short term.

However, the volatility of the underlying makes some of those terms irrelevant.

"You can easily breach the 20% buffer," he said.

For instance, the fund has decreased by 35% in the last eight-and-a-half months, he noted.

"For a 12% return, I can get that with a fully diversified portfolio," he said.

Bad trade, good structure

Scott Cramer, president of Cramer & Rauchegger, Inc., said that the terms of the notes are attractive, but not the underlying view.

"I am absolutely not bullish on gold. I invested in [Deutsche Bank AG, London Branch's DB Gold Double Short exchange-traded notes] from October to January and did quite well," he said.

"I am bearish on this trade. But if somebody wants to be exposed to gold miners, this is a good way of doing it."

He mentioned the buffer and the digital payout as terms that make the note competitive compared to its underlying, especially for an investor who does not anticipate strong growth from the gold mining sector of the equity market.

"From a structural standpoint, I think it's a good product. But the bet is wrong," he said.

Laggards

Some noted the valuation gap between the performance of gold-producing companies and the precious metal.

"The way miners have been lagging physical gold has been really amazing," said Joung Park, mining and metals analyst at Morningstar.

He looked at the SPDR Gold Trust ETF, which is listed on the NYSE Arca under the ticker symbol "GLD." This ETF, with a market capitalization of nearly $64 billion, tracks the price of gold bullion.

"GLD last year was up 10% while GDX was down 16%," he said.

"The main reason is that GLD attracts a lot of money and competes with the miners.

"But there's also the fact that miners incur costs and geopolitical risks as well as operational issues you don't have with physical gold. Their production and capital costs are increasing at a rapid pace. Cost inflation has been kicking out in the last couple of years, and you have constraints [in] labor supply. Even higher prices of gold can lead to higher mining costs because it leads to higher royalties."

Some predict that GDX's lagging price will turn out to be an advantage for investors, making the notes more interesting for investors.

"It seems attractive, especially if you have an existing position because you can hedge some of the downside," a market participant said.

"Gold miners have been performing so terribly in the last couple of years, there is a reason to believe that it's going to improve providing that the bullion doesn't fall to $1,300 or $1,200."

He mentioned two reasons: dividends and trend reversal.

"In order to better compete with gold, a lot of those miners offer dividends over 2%. That's something," he said.

Finally, with gold trading at such a high premium, investors should sooner or later see a buying opportunity, he said.

"If the valuation of the miners continues to fall, at some point the economics will favor GDX even with higher production costs," he added.

Barclays Capital Inc. is the agent.

The notes will price May 24 and settle May 30.

The Cusip number is 06738K5K3.

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