Morgan Stanley’s contingent income buffered autocalls on gold miners ETF unfit for gold bugs

By Emma Trincal

New York, Sept. 30 – Morgan Stanley Finance LLC’s contingent income buffered autocallable securities due Nov. 3, 2021 linked to the VanEck Vectors Gold Miners exchange-traded fund lack an attractive risk-adjusted return for investors who have a strong bullish view on gold and gold miners.

Each quarter, the notes will pay a contingent coupon at the rate of 7.5% to 9.5% per year if the underlier closes at or above its coupon barrier level, 85% of its initial level, on the determination date for that quarter, according to an FWP filing with the Securities and Exchange Commission.

The exact contingent coupon rate will be determined at pricing.

The notes will be automatically called at par plus the coupon if the underlier closes at or above its initial level on any quarterly determination date.

The payout at maturity will be par plus the coupon unless the underlier finishes below its buffer level, 85% of its initial level, in which case investors will lose 1% for every 1% that the underlier declines beyond 15%.

Matthew Bradbard, director of alternative investments at RCM Alternatives, said the notes do not fit his outlook.

“I’m very bullish on gold – bullish on precious metals, gold, platinum, silver...

“Gold got ahead of itself and dropped a little bit since July. In the past couple of years, it has gone up close to 60%.

“But I see more upside.”

Bullish

Bradbard, whose firm is a commodity trading adviser, said he would have to look at the correlation between gold prices and gold miners.

“If gold and gold miners are correlated, I don’t like the deal. I’m too bullish on the commodity,” he said.

The correlation is relatively high: the gold miners ETF has a one-year coefficient of correlation of 0.85 with the SPDR Gold Trust Shares ETF, a fund that tracks the price of gold bullion.

“It’s my understanding that gold miners are much more volatile. It’s a bumpy ride. If gold is up, you move up more. And there’s a lot of downside risk,” he added.

The gold miners fund has an implied volatility of 43%, which is twice as high as the volatility of the SPDR Gold Trust Shares ETF.

“That 15% buffer, I love that. But you can lose a lot more money than that,” he said.

Seeking alternatives

However, Bradbard said there is a need for this type of note.

“Just because I wouldn’t have a use for this doesn’t mean that wouldn’t work for someone else,” he said.

“The 60/40 portfolio is no longer the panacea. You need alternatives.”

The term 60/40 designates a classic type of asset allocation consisting of equity with a 60% weighting and fixed income with a 40% weighting. But with yields at record lows, investors have cut their allocation to traditional bonds.

“People are chasing returns. Fixed income is effectively yielding zero. In that case, structured notes like this one provide some form of fixed-income replacement.

“It wouldn’t be what I sell to my clients. But I can understand why some people would find it attractive,” he said.

Risk-adjusted return

A market participant, also bullish on gold, said he did not like the notes.

“What an awful way to play the gold miners...I’m a gold bug and gold is very volatile. But gold miners are gold on steroids,” he said.

“Even with a 15% buffer you’re taking on a lot of risk. Gold can be down 40%. To take that much risk and not being compensated with a real good upside to me doesn’t make sense. What is a 7.5% or 8.5% coupon for a fund that can be up 40% or 50% on any given year?”

His concern about the risk-adjusted return was not a criticism of the pricing.

“I’m not saying that statistically it’s not a fair coupon.

“What I’m saying is that you’re limiting your upside way too much,” he said.

Fundamentally good

This market participant said he is bullish on gold miners in large part due to the sector’s fundamentals.

“According to experts, energy is about 30% of the input of gold mining costs,” he said.

“Energy prices are very low. That makes the cost of mining much cheaper.

“A lot of those mining companies have cleaned up their act. Their creditworthiness has improved, and they’ve reduced costs”

“The fundamentals are very compelling

“Do you think Warren Buffet decided to invest in gold just to make 8.5%?”

Buffet purchased shares of gold-mining stock Barrick Gold for half a billion dollars in the second quarter, according to a 13H filing with the SEC.

Barrick Gold is the second largest holding in the VanEck ETF with a weighting of nearly 12% out of 54 components.

Leverage preferred

Another issue for this gold bull was the automatic call feature.

“That’s a problem too. If the miners go on a tear and you get called out with a 2% return, then what?”

The underlying asset class was attractive, but not the structure.

“Gold and gold miners are very volatile. They can shoot all the way to the moon or they can crater.

“How can you be lukewarm about gold miners?

“What you need with that asset is an accelerated barrier note, not an autocall.”

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes will price on Oct. 27 and settle on Oct. 30.

The Cusip number is 61771EAS7.

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