Citi’s contingent coupon autocalls on Gold Miners ETFs show defensive barrier, low return

By Emma Trincal

New York, Oct. 23 – Citigroup Global Markets Holdings Inc.’s autocallable contingent coupon equity-linked securities due Oct. 31, 2023 linked to the worst-performing of the VanEck Vectors Gold Miners exchange-traded fund and the VanEck Vectors Junior Gold Miners ETF offer a relatively low-risk profile despite the volatility of the underlying, said a contrarian investor.

The notes will pay a contingent quarterly coupon of 7% per annum if each ETF closes at or above its 50% coupon barrier level on the determination date for that quarter, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par plus the contingent coupon if each ETF closes at or above its initial level on any quarterly call observation date starting after six months.

The payout at maturity will be par unless any ETF closes below 50% of its initial level, in which case investors will be fully exposed to the decline of the least performing ETF from its initial level.

Low barrier

“7% is a pretty small return. If you’re bullish obviously you can implement strategies that are much more aggressive,” said Steven Jon Kaplan, founder and portfolio manager at True Contrarian Investments.

“At least the issuer gives you a low barrier. GDX or GDXJ would have to fall by half before you lose money. That’s significant.”

The VanEck Vectors Gold Miners ETF and the VanEck Vectors Junior Gold Miners ETF are both listed on the NYSE Arca under the ticker “GDX” and “GDXJ,” respectively.

Kaplan focused on the Junior ETF, which is the most volatile of the two. Its share price closed at $56.44 on Friday.

March pullback

“A 50% drop is huge. In March, GDXJ dropped by more than half, but that was under very unusual circumstances. People were dumping everything at the time, even Treasuries, just so they could meet their margin calls,” he said.

The ETF dropped 57% to a 52-week low of $19.52 on March 13 from a February high of $45.08.

“GDXJ is in much better standing now. It’s been making higher lows.

“A 50% drop would take you below 30, at around 28. I think it’s unlikely for this timeframe,” he said.

It would be even “less likely” for the VanEck Vectors Gold Miners (GDX), which is a large-cap sector fund, he added.

Volatile juniors

The junior version, which consists of smaller and medium size gold mining companies, is the most volatile of the two. Its implied volatility is 48.61% versus 39.85% for the other fund.

“GDXJ would drop a lot more. It’s 20% more volatile than GDX,” he said.

The top two holdings of the VanEck Vectors Gold Miners are large-cap Newmont Corp. and Barrick Gold Corp.

Kinross Gold Corp. and Gold Fields Ltd ADR are the top two constituents of the VanEck Vectors Junior Gold Miners.

Kaplan used a five-year chart to base his assertion that the Junior ETF is unlikely to lose half of its value or drop below 30.

“I see support between $35 and $40. I’ve been trading the ETF for so many years, it’s been the pattern,” he said.

Bullish trend

Support is a line joining previous lows, below which the price has not fallen for a specific period.

“The ETF recovered from March to June then really took off when the media got excited about the sector,” he said.

Two things happen in the summer, he explained. First the yellow metal itself hit an all-time high at $2,000.

“It was a big round number. The media love that,” he said.

Then on Aug. 5, the “Junior” ETF hit a new high at $65.95.

“At that point people started piling in gold miners,” he said.

“As always, the trend will turn, and people will start getting negative again.”

Be he said he sees the share price drop to $40, not $28 or $30.

“I sold GDXJ at $63. I would buy it back at $40.”

Kaplan sees good fundamentals keeping the share price above its support level. The Federal Reserve’s money printing and massive government spending programs are likely to fuel inflation, making gold – one of the best hedges against it – more appealing, he noted.

Both technical and fundamental factors increase the odds for noteholders to collect their coupon payments. But the notes will be redeemed early.

Upside outcomes

“It’s going to be called away in April, July or October. One of those three,” he said.

“It it’s not called, of course there’s always a chance that you would finish 50% lower at maturity. But again, I don’t see it. I think there’s a very small chance. It’s not impossible but it’s improbable.

“These things can drop a lot but as soon as it gets really cheap it rebounds. People buy the dip.

Headlines play a great role in the way gold miners trade, he noted.

“The media was negative about the sector then turned positive around 2010, 2011. then negative again for some time.

“In August GDX jumped when Warren Buffet bought the shares of Barrick Gold.

“Now that we’ve seen so much excitement, things will calm down again.

“If the market drops, gold drops even more,” he said.

“During a sell-off, people are long the dollar and sell most everything else including gold, and they do that indiscriminately. It’s the risk off scenario. We saw a lot of that in March.”

Lackluster gain

But such scenario is offset by the appeal of gold when inflation looms, which, in his view, is already happening even though the market has not noticed yet.

“When people expect inflation, the dollar weakens, and they buy gold. Gold does especially well when real interest rates are negative, which is the situation we’re in now. When inflation is higher than your interest rates on your savings account, you’re losing in real terms and that’s bullish for gold,” he said.

The opportunity cost of owning the precious metal, which bears no interest, is much lower when rates are near zero, he added.

“There’s nothing wrong with owning a note that pays 7% especially when the barrier is 50%.

“Except that 7% is really low. I think you could probably find other methods to get a higher return with less risk,” he said.

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the underwriter.

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

The Cusip number is 17324X5J5.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.