JPMorgan’s buffered notes on Bloomberg Commodity to follow several recent commodities deals

By Emma Trincal

New York, Jan. 23 – JPMorgan Chase Financial Co. LLC’s 0% buffered return enhanced notes due Jan. 29, 2021 linked to the Bloomberg Commodity index show attractive terms for investors willing to invest in an unpopular asset class, sources said.

Some noticed recent activity in the asset class, but it is too soon to tell if the bid away from equity will be an emerging trend this year.

Commodities deals are uncommon, but the New Year has seen a few recent offerings that may suggest renewed interest on the part of investors despite – or perhaps because of – low oil prices and the uncertain direction of gold futures.

If the underlying index finishes above its initial level, the payout at maturity will be par plus 2 times the gain up to a maximum return of at least 22.5%, according to a 424B2 filing with the Securities and Exchange Commission.

If the asset falls by up to 10%, the payout will be par.

Otherwise, investors will lose 1% for each 1% decline beyond the buffer.

Decent terms

“Given where we are right now with commodities fairly low and although I’m not a big fan of structured products, this is actually something where you have a chance of making money for somebody,” said Howard Simons, president of economic consultancy firm Rosewood Trading.

“Prices are down for the asset class. We don’t see any current supply shortage or any kind of demand spike that may suggest higher prices looking forward,” he added.

The Bloomberg Commodity index is composed of futures contracts on physical commodities and is designed to be a diversified benchmark for commodities as an asset class, according to the prospectus.

The index declined 9.5% in the past two years. It is up 4.5% for the year to date.

A few recent deals

This upcoming offering is not an exception in this early part of the year.

Already four commodities-linked deals have priced in the past two weeks for a total of $30 million.

The largest one came out Jan. 4. UBS AG, London Branch priced $13 million of four-year capped in-leverage securities linked to the light sweet crude oil (WTI) futures contracts, according to data compiled by Prospect News. Last week, Morgan Stanley Finance LLC priced $10.28 million of one-year buffered digital notes linked to the S&P GSCI Crude Oil Index – Excess Return. JPMorgan Chase Financial priced a small deal on the WTI as well as another to gold for $5.1 million. More are coming up.

Last year, GS Finance Corp. priced $122.115 million in separate add-ons based on the Bloomberg Commodity index.

Commodities however are with foreign exchange the forgotten underlying asset class. Last year, commodities-linked issuance made for less than 1% of the U.S. market versus two-thirds for equity indexes, according to data compiled by Prospect News.

Glorious years

“I’m not sure that it’s the case today but back in 2004-05, everything in commodities was in backwardation except gold. We were pricing so much stuff with unbelievable terms. It was glorious,” said a market participant.

“I remember doing a three-year point-to-point uncapped with 100% principal-protection. These were the good old days.”

Backwardation refers to the downward sloping shape of the forward curve, which represents the plotting of the futures contract prices at points in time from spot to long-term expiration dates.

When the curve is in backwardation, the market anticipates lower prices in the future, which cheapens the cost of hedging the contracts, he explained.

The opposite scenario, called “contango,” is when the futures curve is positively slopped.

In contango, prices for the distant delivery months are higher than the nearby contracts. As a result, purchasing longer-dated contracts and selling expiring contracts in order to roll the position will generate a cost.

This premium creates a negative “roll yield,” which erodes the return of the investment if the position is long.

The shape of the future

“When in contango you go out in time and people anticipate higher prices. Calls therefore are expected to be in the money so these call options will cost you more,” the market participant said.

Since a call is a bet on a rising price, the more likely the bet is to win, the more expensive the price of the option. If prices are seen as rising, the premium, or the cost to buy the option, will increase.

“Commodities give you an edge when the forwards curve is in backwardation. It’s a little bit similar to what you can get in equities when you have a low interest rate environment with higher dividend-yield stocks,” he noted.

A renewed bid on commodities notes – if there is one – could also be due to investors’ perception of risk in equities. Commodities can often be seen as negatively correlated to stocks and perceived as a tool to diversify a portfolio.

Contango

Simons suggested that commodities at the moment are not in backwardation. Therefore, the shape of the futures contracts curve offers no particular boost or incentive to price derivatives products on the asset class.

“Whether the Bloomberg Commodity index is in contango or backwardation depends on the underlying commodities. The index itself is a spot index,” Simons said.

“Overall though most commodities are in contango right now, not more than usual but for the most part.”

He cited a few exceptions: gold for instance is now trading in backwardation as the price to store the precious metal is relatively inexpensive.

Simons emphasized the difference between spot prices and prices seen on the forward market. Forwards are the prices set for future delivery.

“Right now prices are low in commodities. Crude oil, in particular is low. The forwards suggest higher prices in the future,” he said. As a result, most commodities are now in contango.

“This is not like the boom years. You had huge spikes in price,” he added.

He was referring to 2008 for instance when the price of crude oil was at $140 a barrel, nearly triple its current level.

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes will price on Jan. 28.

The Cusip number is 48130UQA6.

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