Gold Plunge Risks Losses on $1.1 Billion of Structured Notes

Investors who bought almost $1.1 billion of U.S. structured notes tied to gold may face losses after the commodity dropped 18 percent this year following more than a decade of gains.

About $840 million of the securities, or almost two-thirds of the total issued since January 2010 that have yet to mature, most recently traded below their face value, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. Over that period, banks have sold a total of $1.28 billion of gold-linked notes in the U.S. that remain outstanding, according to data compiled by Bloomberg.

On April 15, gold for immediate delivery fell 9.1 percent, the most in 30 years, after dropping 5 percent three days earlier. Many structured notes that track the price of the precious metal have buffers that absorb losses if the commodity declines, beyond which investors risk losing either principal or coupon payments, Bloomberg data show.

“I think the time to panic was before Friday of last week,” said Michael Gayed, co-portfolio manager of the ATAC Inflation Rotation Fund in New York. “After that, you’re kind of stuck.”

The spot price of gold rebounded about 2 percent in the last two days, to $1,376.25 an ounce yesterday. The last year when the price dropped was 2000, when it declined 5.5 percent.

Related story: Gold Miners Lose $169 Billion as Price Slump Adds ETF Pain

Barclays Plc (BARC) (BARC) sold $143.2 million of one-year, gold-tied notes on Sept. 28, the largest such offering in the U.S. since 2010 that has yet to mature. The securities yield as much as 17.5 percent of the metal’s gains and protect against 15 percent of losses with all capital at risk, according to a prospectus filed with the U.S. Securities and Exchange Commission.

Below Par

The notes, which JPMorgan Chase & Co. sold for a 1 percent fee, have traded below par since being issued, according to Trace. Investors exchanged the securities at 79.8 cents on the dollar yesterday, the lowest price this year.

Citigroup issued $7.79 million of two-year, gold-linked notes that traded at 75.4 cents on the dollar on April 15, their lowest this year, according to Trace. The securities, also sold on Sept. 28, pay as much as 30 percent with 10 percent protection against losses, according to a prospectus filed with the SEC.

Other notes, including almost all of the $195.4 million that guarantee a return of principal, have remained at par or climbed in value, benefiting from yearly gains in gold as high as 30 percent in 2010.

Notes Rise

Bank of America Corp. sold $77.6 million of five-year notes on June 24, 2010, the largest offering in the last three years to rise above par, based on the most recent trading data. The securities yield as much as 70.55 percent of gold’s gains and protect capital from losses, according to a prospectus filed with the SEC.

The notes traded for 110 cents on the dollar yesterday, according to Trace.

Mark Lane, a spokesman for Barclays, Matt Card, a spokesman for Bank of America, and Scott Helfman, a spokesman for Citigroup, declined to comment on the notes and secondary trading.

Related content: The Real Cost of Owning Gold

The outcome for the U.S. gold-tied securities, which have maturities as long as eight years, depends on whether the metal’s price bounces back. Investors haven’t reached a consensus on that, said Heiko Geiger, who heads public distribution of structured products for Germany and Austria at Vontobel Holding AG in Frankfurt.

‘Flash Crash’

“The plunge in gold this week had the character of the ‘flash crash,”’ he said. “The bulls and the bears are now fighting with each other, and no one knows who will win.”

The most actively traded gold-linked certificate on Europe’s exchanges yesterday was a call warrant issued by Zuercher Kantonalbank (ZKAN) that has a strike price of $1,400, according to Bloomberg data. Investors traded 3.2 million Swiss francs ($3.4 million) of the security.

Banks create structured notes by packaging debt with derivatives to offer customized bets to retail investors while earning fees and raising money. Derivatives are contracts whose value is derived from stocks, bonds, commodities and currencies, or events such as changes in interest rates or the weather.

To contact the reporter on this story: Kevin Dugan in New York at kdugan4@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net

Press spacebar to pause and continue. Press esc to stop.

Bloomberg reserves the right to remove comments but is under no obligation to do so, or to explain individual moderation decisions.

Please enable JavaScript to view the comments powered by Disqus.