HSBC’s autocallable notes linked to Gold Miners ETF can be used as income play, partial hedge

By Emma Trincal

New York, Aug. 26 – HSBC USA Inc.’s contingent income autocallable securities due Sept. 4, 2015 linked to the Market Vectors Gold Miners exchange-traded fund offer income opportunities as well as a relative play on gold, sources said.

Each quarter, the notes will pay a contingent coupon at an annual rate of at least 8% if the fund closes at or above the 80% downside threshold level on the determination date for that quarter, according to an FWP filing with the Securities and Exchange Commission.

The notes will be called at par plus the contingent coupon if the fund closes at or above the initial share price on any of the first three quarterly determination dates.

If the notes are not called and the fund finishes at or above the downside threshold level, the payout at maturity will be par plus the final coupon. If the fund finishes below the downside threshold level, investors will be fully exposed to the share price decline.

Short and sweet

Dean Zayed, chief executive officer at Brookstone Capital Management, said that income is the main rationale behind the trade, regardless of the actual duration of the notes, which may be as short as three months if the autocall occurs on the first call date.

“In this low interest rate environment where people are thirsty for yield, we don’t think we have to hold [a] position for an extended period of time if you’re seeking income,” he said.

“I’m very much OK with an autocallable. You can make money in a short period of time and get more income than what you would have had in a fixed-income instrument.”

The probability of an autocall being triggered is the highest on the first call date, he noted, which makes it possible for investors to hold the security for only three months.

Zayed said that it is not a problem.

“We don’t get emotionally attached to the product if it gets called,” he said.

The likelihood of a call will increase if gold follows a bullish trend, which fits with Zayed’s outlook.

“We like the gold miners. Recently, they have broken out after a couple of rough years. We’re very bullish on this asset class. I like this play for the structure and also because I’m bullish on the ETF. I like the miners whether as part of an income play, as it’s the case here, or as a growth strategy,” he said.

“If it gets called after three months, you’ve made more money in that short period of time than in something else.

“You have to see it as a positive and not get emotional about it.”

Mildly bearish

Jonathan Tiemann, founder of Tiemann Investment Advisors, LLC, compared the performance of the Market Vectors Gold Miners ETF, which is listed under the NYSE Arca symbol “GDX,” and the SPDR Gold Trust ETF, which trades under the symbol “GLD.”

The first ETF tracks the performance of publicly traded companies involved in gold mining worldwide; the second tracks the price of the precious metal.

“There might be a way to do it as a relative play with gold. We know that the miners tend to fall much more than gold during a downturn,” Tiemann said.

“If you plot the five-year chart, you’ll see that gold and the gold stocks traded pretty close during the first couple of years, but then gold declined and the GDX fell much more sharply.

“If gold begins to trade below a certain price, the miners get hammered. The price at which they can sell falls below their operational cost and the bottom line is going to take a hit.”

Tiemann said that investors’ best outcome with the notes would be if the gold mining stocks traded negatively but not down by more than 20%. In such scenario, investors may continue to clip the coupon each quarter, accumulating more gains.

“That’s the ideal situation: anywhere between 80% and 100%. You have to be mildly bearish on the miners,” he said.

Partial hedge

Providing that the ETF stays in that range, investors may be able to use the note for another purpose than just income.

“You may be able to use it as a kind of partial hedge for gold,” he said.

“Say that you’re long gold and you hold those notes. If the price of gold drops, the miners are likely to follow. You want the miners to go down. They can even go down more than gold as long as they don’t breach that 80% threshold.

“If gold falls and the miners decline a little bit but by no more than 20%, what you lost in gold is partially offset with the coupon. It’s not a perfect hedge. It’s more of a partial hedge, but it’s something.

“Your risk is if the gap between gold and the miners widens to a point where the miners begin to trade outside of the range on the downside.

“As an example: if gold is down 10% and the miners fall by 18%, you’re good. The coupon you earned on this quarter helps you offset some of the loss. But if the miners drop by 25%, then you’re in trouble. Your hedge no longer works for you. It’s really a range-bound trade, and the hedge is not perfect.”

The performance gap between gold and the gold mining stocks is also notable on the upside, he said.

So far this year, the gold ETF has gained a little bit more than 6% versus 24% for the miners.

“There is obviously some upside risk with this trade,” he said.

“If the market takes off and you get called just after three months, you get your 2%. It’s better than a stick in the eye, but it’s not what you’re looking for.”

HSBC Securities (USA) Inc. is the agent.

The notes are expected to price Friday and settle Sept. 4.

The Cusip number is 40434D772.

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