Agents priced $920 million; giant commodities trades suggest renewed interest in asset class

By Emma Trincal

New York, Nov. 26 – Just ahead of the closing of the month, the volume of structured products issuance was seen as robust last week, with agents selling $920 million in 158 deals.

Issuance size however was skewed by the pricing of three big commodities deals, which hit the market, one of which exceeded $300 million in size, the biggest offering by far in this asset class this year, according to data compiled by Prospect News.

Without those three deals combined, volume would have been average at $400 million.

Despite the strong action seen last week, November appeared still weak as of Friday, but things could change.

Bank of America is pricing this week, prior to the Thanksgiving weekend, which may raise November in the monthly ranking in terms of volume. So far, the month is at the bottom of the list with $1.65 billion.

Compared to a year ago, however, November to date is much stronger, up 41% from $1.16 billion.

Bank of America’s contribution to the month remains a wildcard as of press time on Tuesday.

This agent, the No. 1 by far, can in some month-ends price as much as 50% of the total market or even more, according to the data.

Biggies

One surprise from last week and also the year is the resurgence of investors’ appetite for commodities.

Month after month, sales of notes tied to this asset class were on the decline, but the trend seems to have finally reverted.

Agents so far have sold $2.22 billion in commodities, a 38.50% increase from last year’s $1.60 billion, according to the data. While the market is still equity-centric – equity-linked notes make for 81.5% of the year-to-date volume – commodities as part of the overall volume saw an increase to nearly 6% from 4.85% last year.

Meanwhile, total volume this year, all across asset classes, is up 14.40% to $37.91 billion from $33.14 billion.

“It’s picking up,” said Fabrice Hugon, senior managing director, structured products at Elkhorn Investments, about commodities-linked notes issuance.

Top commodities trade

The largest commodities offering was brought to market by JPMorgan Chase & Co., which priced $311.34 million of 0% return notes due Nov. 25, 2016 linked to the Bloomberg Commodity Index 3 Month Forward Total Return.

The index is a version of the Bloomberg Commodity index that trades longer-dated commodity futures contracts, with the delivery months for the reference contracts three months later than those of the reference contracts used for the Bloomberg Commodity. The index is composed of exchange-traded futures contracts on physical commodities and is designed to be a diversified benchmark for commodities as an asset class, with component weightings determined primarily based on liquidity data.

The product was structured as a tracker minus an investor fee.

“It’s an asset manager or a mutual fund, I bet. Usually, when you see a big trade on a single commodity, it’s often the case. They try to get exposure to a specific commodity,” said Hugon.

The day before, on Thursday, JPMorgan priced the same deal – also a delta one product – with a maturity date of Nov. 23, 2016 for $101.26 million. It was the No. 3 offering for the week and the seventh largest commodity deal of the year.

“For sure, I see a 1940-Act fund buying this type of deal. They have restrictions or mandates that prevent them from buying commodity directly so they typically use notes to get the exposure,” Hugon added.

Out of the eight commodities offering in excess of $100 million, which have priced this year, three hit the market last week, according the data.

The third one on this list and second in size seen last week was based on a metal.

Morgan Stanley priced $106.24 million of 0% buffered return enhanced notes due Dec. 9, 2015 linked to palladium.

The notes offered a 116.3% participation rate on the upside with an 11.63% cap. The 10% geared buffer showed a 1.11 leverage factor.

“I think we are likely to see more commodities-linked notes as QE3 is done and investors are once again focusing on the inflationary effects we might face soon,” said Dean Zayed, chief executive officer of Brookstone Capital Management.

Tactical bets

Among the biggest commodities deals to have priced so far, the use of traditional broad-based commodity benchmarks such as the S&P GSCI has strongly declined, according to the data.

Instead, investors have made single commodity bets especially on oil or some metals, such as palladium, avoiding gold.

West Texas Intermediate light sweet crude oil is by far the most widely used underlying, according to data, accounting for $653 million in 60 deals, or 30% of the notional in commodities issuance.

“We looked at WTI structures and they appear to be interesting,” said Hugon.

“You can get a 13-month with a 9% coupon and a 10% to 15% hard buffer, one-to-one.

“With oil prices pushed down as they are now, you get a lot of volatility and it helps a lot.”

Hugon agreed that investors seem to have shied away from the widely recognized benchmarks.

When buyers use indexes, they tend to prefer smart beta or proprietary indexes such as the Bloomberg Commodity Index 3 Month Forward Total Return; the J.P. Morgan Enhanced Beta Select Backwardation Alternative Benchmark Total Return index; or the Merrill Lynch Commodity index eXtra Energy Excess Return, according to the data.

“Nobody likes the broad indexes anymore. If you look at the performance of commodities in general, no one wants that kind of exposure. People want to be more tactical,” he said.

The S&P GSCI Commodity index has dropped 13% this year. Just over the past month, the benchmark lost 6%.

“Investors prefer to pick commodities and make tactical plays on oil, copper, palladium or natural gas,” he said.

“The oil trade is definitely a bottom fishing strategy,” he said.

Oil prices have dropped by 30% since June.

“People are hoping that oil is bound to recover. They see value at those levels,” he added.

“Metals are a bit tricky because it all depends on growth in the emerging market economies and we’ve seen that growth has been stagnant, especially in China.

“Oil is driven more by macroeconomic factors and the political environment. You can have a much more tactical play with oil.

“The commodity bull market has run its course for now with the dollar strengthening and growth in emerging markets fading. Now people want to bet selectively on dislocations in oil prices, metals.”

Equity

Hugon said that equity remains by far the dominant driver of volume.

“We had a pretty strong year when you look at it. The S&P is up 12%. The bull market in equity is good for structured products because most underlying assets are in equity. Both markets are highly correlated,” he said.

For a sellsider, the commodities bid seen recently, especially last week, may just be temporary.

“I don’t see the asset class gaining momentum,” he said.

“First, the stronger dollar is poison for commodities. And second, the argument of using commodities as a hedge against inflation doesn’t hold, at least not yet. Everybody is depreciating their currencies. People are trying very hard to re-inflate their economies. I don’t see any inflation.”

Oil would “make more sense,” he said, given today’s low levels.

“Oil can’t drop forever. I don’t see it going down below $60 [a barrel]. At some point, supply will re-adjust. If the price of oil no longer justifies drilling, U.S. oil companies will cut supply. You can’t continue to produce something when margins just aren’t there.”

Among the top deals and ranked as No. 7, JPMorgan priced an international equity offering with $30.42 million of 0% digital equity notes due Nov. 25, 2016 linked to the Euro Stoxx 50 index.

If the index return is greater than or equal to negative 5%, the payout at maturity will be a digital return of 18.5%. If the index return is less than negative 5%, investors will lose 1.0526% for each 1% decline beyond 5%.

“It would be interesting to know if the European story continues to be strong,” said Hugon.

“A lot of investors have piled on the Euro Stoxx. I wonder if we’ll see the trend fading a little bit given the economic slowdown in Europe,” he said.

Citigroup

On the rates front, Citigroup Inc. last week priced $42 million of leveraged callable CMS curve-linked notes due Nov. 26, 2034 linked to the 30-year Constant Maturity Swap rate and the two-year CMS rate. It was the fourth largest deal. Interest will be 10% for the first year. After that, it will accrue at 10 times the spread of the 30-year CMS rate over the two-year CMS rate minus 87.5 basis points, up to a maximum interest rate of 10% per year. Interest will be paid quarterly. The payout at maturity will be par.

The notes will be callable after one year. Morgan Stanley & Co. LLC is the dealer.

In equities, the top deals were tied to non-U.S. benchmarks.

Goldman Sachs Group, Inc. priced $34 million of 0% notes due Feb. 24, 2015 linked to the Topix index, a repeat tracker. Separately, HSBC USA Inc. priced $22 million of 0% notes due Jan. 26, 2015 linked to the Topix index, as well. These trades were No. 5 and No. 8, respectively.

“Stock markets like Japan clearly benefit from monetary stimulus. This is a play on Abenomics,” Hugon said.

The term refers to the monetary easing policy implemented by Japanese prime minister Shinzo Abe.

“Investors increasingly think that the U.S. market is a bit toppish. They are looking to diversify,” said Hugon.

The Dow Jones industrial average and the S&P 500 index hit new highs intraday on Friday amid China’s rate-cut announcement and the European Central Bank suggesting more monetary easing ahead.

“The markets like easing. They like to see low interest rates and liquidity,” Hugon said.

The top agent last week was JPMorgan with $506 million in 19 deals, or 55% of the total. It was followed by Morgan Stanley and Goldman Sachs.

“I think we are likely to see more commodities-linked notes as QE3 is done and investors are once again focusing on the inflationary effects we might face soon.” – Dean Zayed, chief executive officer of Brookstone Capital Management

“A lot of investors have piled on the Euro Stoxx. I wonder if we’ll see the trend fading a little bit given the economic slowdown in Europe.” – Fabrice Hugon, senior managing director, structured products at Elkhorn Investments

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