Goldman Sachs' trigger notes tied to gold offer high cap, buffer, but gold sell-off is a risk

By Emma Trincal

New York, June 24 - Goldman Sachs Group, Inc.'s upcoming trigger notes linked to gold may attract investors with its structure offering both a high cap and some downside protection, but the underlying asset may be risky as gold keeps reaching new highs, sources said.

Goldman Sachs plans to price 0% commodity-linked trigger notes due Dec. 30, 2011 tied to the spot price of gold, according to a 424B2 filing with the Securities and Exchange Commission.

If the price stays above the trigger amount - 80% of the initial price - during the 18-month term of the notes, the payout at maturity will be par plus any gain, up to a maximum settlement amount of $1,750 per $1,000 note.

If the price ever dips below the trigger, the payout will be par plus the return with exposure to any losses. Any gains will be capped at 75%.

Strong rally

"It's an interesting structure but not without risks," said Steve Doucette, financial adviser at Proctor Financial.

"Gold has hit new highs and is bound for a pullback as market makers and traders may be trying to get out and capitalize on their gains," he added.

Gold is trading at $1,230 an ounce, up nearly 11% in the year to date.

Over the past 18 months, the precious metal has jumped by 37.5%, and it is up by 33% compared to one year ago.

75% cap, trigger

"You have to be bullish on gold, obviously, and you have to believe that spot prices won't drop by more than 20% during the period. On the upside, the 75% cap is pretty high. If gold doubled in price during that period, then yes, you would be capped at 75%. But I doubt that gold would double. So I think that 75% is a nice cap on the upside," said Doucette.

The notes offer through the trigger mechanism some level of protection, although it is slightly different from a traditional buffer, Doucette noted.

The protection only works when there is no trigger event, according to the prospectus.

If gold never falls below 80% of its initial price on any day during the 18-month term, investors would get their principal back even if the final price ends up negative as long as its decline does not exceed 20%, the prospectus said.

For instance, if a trigger event has not occurred and the final gold price falls by 15%, investors would get par back.

On the other hand, if the trigger occurs, investors would have no protection at all. For instance, if the trigger occurs and the price ends up down 21%, investors would lose 21% and not 1%, according to the prospectus.

Doucette said that it was risky to be invested in notes tied to a single commodity.

"We usually prefer indexes if we play commodities," he said.

Gold rationale

However, he stressed some of the benefits of gold as an underlying asset, saying that there is a case to be made for being bullish on gold.

"With the uncertainty out there, everybody looks for gold for safety. And there's still a lot of uncertainty," he said.

As a rule, gold has attracted investors looking for diversification, Doucette noted.

"A pure gold play may also offer a good hedge against a stock market downturn. It may be a good diversification tool. From that standpoint, I think the 20% buffer is great," he said.

Cautious bull

Matthew Tuttle, chief executive officer of Tuttle Wealth Management, said that he owns gold and has invested in it via exchange-traded funds. Yet, he is prepared for a reverse in the rally trend.

"I am cautiously bullish" on gold, he said. "Gold is a strange animal because there are so many different factors that affect its price."

"We own it, and we've made a lot of money. We're trend followers by nature. When the trend is up, we're in. The trend in gold is up," he said. "But when the trend starts to go down, we're out. Right now we're bullish. But we're not gold fanatics. We're concerned that gold has gotten a little bit bubbly."

Liquidity concern

Tuttle said that while the note was designed for gold bulls like himself, he would not be interested in the product given its limited liquidity.

"There are so many people in gold, and it's such a small doorway to get out. If people start selling, you could see a 20% decline over one year and a half. We're not predicting it. We own it. But I wouldn't want a structured note because of the lack of liquidity. I'd like to have the ability to get out quickly, if I need to."

Goldman, Sachs & Co. is the underwriter with J.P. Morgan Securities Inc. as co-agent.

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