BMO’s 12.6% autocallables tied to VanEck Gold Miners not seen as ordinary retirement income

By Emma Trincal

New York, July 7 – Bank of Montreal’s 12.6% autocallable cash-settled notes with fixed interest payments due July 31, 2017 linked to the VanEck Vectors Gold Miners exchange-traded fund provide investors with a high and fixed monthly coupon, but it would be a mistake to use the notes as a traditional substitute for fixed-income, financial advisers said.

If the fund finishes above the 110% call level on any monthly call date, the notes will be called at par plus the coupon, according to an FWP filing with the Securities and Exchange Commission.

The payout at maturity will be par unless the fund finishes below initial level and ever closes below the 65% trigger level during the life of the notes, in which case investors will be fully exposed to any losses.

“It’s a high coupon, but it’s also a lot of risk,” said Matt Medeiros, chief executive of the Institute for Wealth Management.

GDX versus GLD

He pointed to the volatility of the underlying ETF.

The fund, which is listed on the NYSE Arca under the symbol “GDX,” is comprised of companies involved in mining for gold or silver. As an equity fund, it differs from the SPDR Gold Trust fund (“GLD”), which is the most-widely traded commodity ETF for the precious metal itself.

“When you see gold prices rise as they have so far this year, the gold miners can rise two, three or four times more than the actual precious metal,” he said.

“The inverse is also true. When GLD drops, GDX drops even more.”

The VanEck gold miners ETF used in the notes has seen its price more than double this year. The fund has gained 116% compared to a 28% positive return for the GLD fund.

“With that in mind, the miners are an interesting play in the market at this stage,” said Medeiros.

“My concern would be, because of the volatility of the underlier, that you would be exposed to major losses. I’m not sure what the advantage is when you buy these notes versus the ETF.”

Barrier

His view would be different if the structure offered a buffer rather than a barrier on the downside.

“It would make more sense to me because I could mitigate some of the downside risk.

“But in this case, because of a rapid rise in the index, a decline past the barrier is highly likely. Conversely, being called away in any given month is also likely.”

A breach in the barrier puts investors at risk of losing up to 100% of their capital as the protection is no longer in place once the barrier is hit. The barrier used in the notes adds even more uncertainty because it is observed on a daily basis rather than just once at maturity. Those types of triggers are known as “American barriers.”

“The American barrier is much more challenging to model especially with an index as volatile,” he said.

Autocall

The autocall in Medeiros’ view is likely to happen, based on recent price moves. For instance, the share price of the ETF over the past month has already jumped 18%.

An automatic redemption while it removes risk presents some disadvantages, he said, such as the interruption of the interest payments and the exposure to reinvestment risk.

“I’m not sure that I have transferred any of the risks when using the notes versus being long the index,” he said.

“If the economy picks up, if people start to sell off gold, the share price of miners is going to drop very quickly.”

Return capped

On the upside, investors in the notes see their return capped at the coupon rate of 12.6%.

“It’s a pretty good yield. On the other hand, the ETF itself could be up much more than that,” he said.

“You’re likely to do more than 12% not in a year but in a month. In fact, it has actually happened.”

In the first half of this year, the ETF has shown a monthly positive return of 14% on average.

Know what you buy

Matthew Tuttle, chief executive officer of Tuttle Tactical Management, said the notes could make sense but under certain conditions.

“If you don’t understand GDX, if you don’t necessarily like the fund but you’re simply looking for yield, I wouldn’t do that,” he said.

Tuttle said his firm owns and trades GDX.

“It’s extremely volatile and you can easily get to the point where you’re down 35%. If you don’t understand it and are not aware of the risks, it’s a problem. A retiree chasing yield with this note has the potential to be disappointed,” he said.

But Tuttle said he was bullish on the ETF.

“We think GDX is going to do OK. We own it. So for us, buying the notes is a great idea. I have no problem at all.”

Bullish

As the upside is capped, Tuttle, should he buy the notes, would use the investment for income. But he would not recommend investors use the notes as a fixed-income substitute.

“You could be up 100% in just a few months; you could be up 10% or down 35% in just one month,” he said.

As a tactical allocator, Tuttle said that his time horizon was relatively short-term.

“My bullishness or bearishness can last from 30 minutes to a few days. We trade GDX and we trade in and out of it,” he said.

Right now this adviser’s outlook on the fund is bullish, which is why he would be comfortable owning the notes.

During times of economic uncertainty and currency depreciation, investors look for gold,” he said.

“Gold is weird. But with Brexit, with what’s going on with the Fed, I think GDX has room to run.”

BMO Capital Markets Corp. is the agent.

The notes will price on July 26 and settle on July 29.

The Cusip number is 06367TGQ7.

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