Citi’s contingent coupon autocalls on S&P, Gold Miners show buffer, lower call strike

By Emma Trincal

New York, Oct. 29 – Citigroup Global Markets Holdings Inc.’s autocallable contingent coupon equity-linked securities due Nov. 30, 2022 linked to the worst performing of the S&P 500 index and the VanEck Vectors Gold Miners exchange-traded fund, is one of the latest deals to provide exposure to mining stocks, a recently rising trend, according to data compiled by Prospect News.

An increasing number of offerings based on silver and gold miners exchange-traded funds have been spotted of late as issuers are attempting to respond to inquiries from investors seeking hedges against inflation or market downturns.

Gold, S&P

Recently Citigroup picked up the same concept but paired the gold fund exposure with the broader stock market, a combination designed to bring more premium as the correlation between the two underliers is much lower. The issuer was able to balance the risk-adjusted return by structuring defensive terms in an attempt to offset some of the dispersion risk.

The notes will pay a contingent monthly coupon at an annualized rate of 8% to 9% per annum if the worst performing underlying closes at or above the coupon barrier, 80% of the initial value, on the valuation date for that period, according to a 424B2 filing with the Securities and Exchange Commission.

The exact coupon rate will be set at pricing.

The notes will be automatically called at par plus the contingent coupon if each underlying closes at or above its autocall barrier value, 95% of the initial value, on any quarterly autocall date after six months.

If the notes are not called, the payout at maturity will be par unless the worst performing underlying finishes below the 85% buffer value, in which case investors will lose 1% for every 1% that the least performing underlying declines beyond the 15% buffer.

Conservative built

One particularity of the structure is the call threshold set below the initial price.

“It’s much more defensive than the average autocall,” a market participant.

“You have a lower call trigger so your chances of getting called are greater. It helps. Plus, you get a hard buffer. That helps too.

“I haven’t priced it, so I don’t know whether the payout is fair or not. But those two things –the lower call strike and the buffer – certainly help reduce the risk.”

Low correlation

To be sure, the risk has a lot to do with potential divergences between the performance of the S&P 500 and the VanEck Vectors Gold Miners fund. Their one-year coefficient of correlation is only 0.318, according to FactSet.

A much more common ETF used with the VanEck Gold Miners is the iShares Silver Trust, a commodity ETF tracking the price of silver. Those two funds display a higher correlation of 0.623. Even that correlation level is notably low compared to correlations between U.S. equity indexes. The S&P 500 and the Dow Jones industrial average, for instance, show a 0.99 coefficient of correlation.

Capped return

Steve Doucette, financial adviser at Proctor Financial, said he did not like the risk-adjusted return of the product.

“The best you get is 9%. You cap your upside. And you can lose 85%,” he said.

“It’s a worst of and it’s the S&P and gold miners. These asset classes could diverge.

“You’re stuck with this worst-of for two years unless you get called, but if you’re not, you could easily blow through the 80% barrier.”

Ideally, investors would be looking to collect their monthly coupon for six months before getting called, he said.

“On the upside it’s hard to imagine this note paying out more than six months,” he noted.

But the downside risk exposure remained. The lower autocallable trigger, which is 5% below the initial price, did not do much to increase the chances of a call in his view.

“If the market really goes down, you’re stuck with it.”

Inflation around the corner

Doucette however has been paying attention to the recent gold and silver trend. Recently, Goldman Sachs showed him some notes, which provide direct or indirect exposure to the two precious metals.

“With gold and silver, you’re not mixing two uncorrelated asset classes,” Doucette said.

“You have a better hedge against inflation when you put gold miners and silver together. With the Fed balance sheet being so high, a lot more people are talking about inflation now.”

Two deals

The first note was a four-year tied to the worst of the VanEck Vectors Gold Miners ETF and the iShares Silver Trust.

It will pay a quarterly contingent coupon of 15% per year based on an 80% coupon barrier. The notes are autocallable quarterly. The barrier at maturity is 60%.

“Silver and gold are more correlated. Your coupon is 15%. There’s no 15% buffer on the downside but a 60% barrier looks pretty good to me,” he said.

The other note, a three-year growth product on the same two underliers, offers 115% uncapped participation on the upside and a 15% buffered protection on the downside.

“That three-year is pretty good. You have leverage, no cap, a buffer rather than a barrier.

“Who knows? Market is up, you might hit through the roof. If not, you can outperform with the buffer.”

Uncertainty

Matt Medeiros, president, and chief executive of the Institute for Wealth Management, commenting on the Citigroup notes said their timing was adequate.

“It’s difficult to predict how the S&P and gold will perform in relation to one another. It depends on the market conditions. You would think they’re not highly correlated. But they’re not negatively correlated either,” he said.

The S&P 500 index and the gold miners ETF were negatively correlated between 2010 and 2013, according to a chart.

During the next few years, gold traded much more sideways while the equity index rallied.

Since the end of 2018, both have been moving upward together, the ETF beginning to rally after the precious metal hit a record high in August 2018.

“In theory if the dollar weakens gold prices should appreciate. This is a plausible scenario since we’re pumping money in the economy like crazy,” he said.

Gold could also rise along with a stock market rally as it has so far, he noted.

Investors should keep in mind that the gold equity fund is more volatile than gold itself, he added.

“We’ve seen gold miners react much more quickly and strongly to moves in the price of gold.”

However, over the next two years, Medeiros does not expect gold prices to move much one way or the other.

“The big volatility is in the S&P. If the market is up, people will focus on investing in stocks.”

Six-month cash-flow

Overall Medeiros said he liked the terms of the note.

“Because we’re so close to the Elections, there isn’t any clear direction. This is a good hedge. The fact that it’s only a two-year is also a positive. You’re not taking a huge amount of risk unless something really bad happens,” he said.

The buffer was also a solid advantage for investors and the 15% buffer size was “sufficient,” he said.

The product served its purpose, which is to generate above-average yield, he added.

“You’re buying this note for the 8% to 9% coupon and it’s a very attractive rate in this environment.

“Corporate rates are down. Treasury rates are down.

“Trying to find a good yield is a challenge.”

Regardless of the lower call threshold (set at 95% versus the initial price of 100%) Medeiros assumed that the notes would get called at the first opportunity.

“I think that in six months, you’ll be paid, and the notes will be redeemed. I don’t think anyone should expect to hold the notes for two years.”

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the underwriter.

The notes will price on Nov. 24 and settle on Nov. 30.

The Cusip number is 17328WYD4.

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