Bank of America ties notes to gold; principal protection prudent as prices gain, adviser says

By Kenneth Lim

Boston, May 28 - Bank of America Corp.'s planned offering of principal-protected notes linked to the price of gold is a timely product that could address concerns about a possible peak in the value of the precious metal, an investment adviser said.

Bank of America, through agent Merrill Lynch & Co., plans to price zero-coupon principal-protected Market Index Target-Term Securities (Mitts) due June 2013 linked to the gold spot price.

At maturity, investors will receive par plus any gain in the price of gold, subject to a total maximum payout of 160% to 166% per $10 note. Investors will receive at least par.

The exact payout cap will be set at pricing.

Upbeat on gold

The product offers exposure to a bullish view on the price of gold, the adviser said.

"You only make money if gold is up," the adviser said. "The principal protection is protection on the downside. You don't lose any money, but you're not making any money either."

A bullish position on gold could attract investors who are taking note of climbing gold prices, the adviser noted.

"Gold prices have been doing nothing but going up," the adviser said. "When the financial crisis hit us, people were flocking to gold as a safe haven. Now the fear is inflation, because the government is pumping all these money into the economy, people are afraid that the U.S. dollar is going to depreciate significantly, and that's driving people to gold. You could say it's really a gold performance."

Appropriate protection

But the same long climb in gold prices is also worrisome because of fears that the rise in the metal's value could be a bubble, the adviser said.

Buying principal protection at this time, when prices are high, is therefore worth more to investors, because the risk of a correction in prices is higher, the adviser added.

"You don't really need principal protection when prices are low," the adviser said. "When prices are high, that's when you start to look over your shoulder and you wonder when is this run going to end?"

Long risk

The adviser was not enamored with the four-year tenor of the product, which is on the longer end of the spectrum among U.S. structured products. Given the volatility and the current run in gold prices, there is a significant risk that gold prices could be below current levels after four years, the adviser said.

"Four years is a long time to be locked into this," the adviser said. "If I only get back my principal at the end of one year, that's a lot easier to swallow than getting back only my principal after four years."

If gold prices are headed for a long rally, investors will also be leaving money on the table if prices exceed the capped payout. But the adviser thinks that opportunity cost should not be a big deterrent.

"So you get 63% instead of maybe 80%," the adviser said. "That's just being greedy. But seriously, you should see it as buying the downside protection at a time when it is prudent to be cautious."

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