JPMorgan's buffered PLUS linked to FX basket not 'straightforward call,' currency analyst says

By Emma Trincal

New York, Sept. 23 - JPMorgan Chase & Co.'s 0% buffered Performance Leveraged Upside Securities due Oct. 30, 2014 linked to a basket of equally weighted currencies relative to the U.S. dollar represent a risky bet given the countries represented in the basket, sources said.

Those are the Brazilian real, the Indian rupee, the Russian ruble and the Australian dollar, according to an FWP filing with the Securities and Exchange Commission.

The payout at maturity will be par of $10 plus double any basket gain, up to a maximum return of 100%. Investors will receive par if the basket falls by up to 12% and will lose 1% for each 1% drop beyond 12%.

Recent sell-off

"It's a big risk-taker, and I'm not sure it's a very easy one for retail investors," a sellside currency analyst said.

"These currencies have been through a recent sell-off. Money managers for a while have had big long positions in emerging markets, sometimes as much as 20% of a portfolio. People have massively invested in this asset class, using fixed income to gain exposure.

"In the recent weeks when the tapering fears were weighing on investors, you saw emerging markets decline a lot as yields were rising. The rupee and other emerging market currencies dropped dramatically as tapering expectations built up. Investors sold their positions through fixed income and through the FX market, pushing down emerging market currencies and bonds. The market turned bullish on the dollar and bearish on emerging market, and that speculation compounded the sell-off.

"When the Fed surprised the market last week announcing its decision to postpone tapering, people who made those bearish bets on the emerging markets got squeezed and the currencies of these countries appreciated again. So making a bullish bet on this basket for the next few weeks makes sense. But having a strong conviction that this trend is going to hold for a year becomes more complicated. It's not a straightforward call at all."

Commodities play

The product also represents a "very aggressive" bet on commodities, this strategist noted.

"But then again, it's a complicated bet," he said.

"If commodities prices do go up, it would certainly be good for some of those countries like Australia and Brazil but not all of them. For instance, a surge in oil prices would accelerate inflation and increase downward pressure on the Indian rupee. India is an oil importer. You have a negative correlation between the Indian rupee and oil.

"On the other hand, other countries, for instance Russia of course, would benefit from higher oil prices.

"So it's not a clear-cut trade. Some countries in the basket are emerging markets. Australia is not. Some are energy dependent; others are oil exporters.

"This trade is a risky bet because those countries are different and the value of their respective currencies is driven by different factors, which sometimes are negatively correlated factors."

Great terms

Carl Kunhardt, wealth adviser at Quest Capital Management, said that currency-linked notes often offer more attractive terms than equity-based products.

"If I don't look at the underlying basket and just take the terms of this product, I love it. Who wouldn't love a 13-month with a 12% buffer, two-times leverage and a 100% cap? It's impossible to get that on a one-year note tied to the S&P 500," he said.

"You often find more attractive terms in currency deals because the only way to do the currency game is through swaps and futures contracts, which offer significant leverage. They're putting down pennies on the dollar to get exposure, and they're still left with piles of cash.

"So it's a great note except for the basket. It's not that I'm bullish on the dollar. I simply have no confidence in these four countries. I am bullish on emerging markets. But this is a very narrow sliver of emerging markets, one that it not particularly appealing."

Not so great basket

"Take Russia. Investors don't trust Russia and for good reasons. They got burned before. Putin has been renationalizing a lot of oil companies, thrown in jail the oligarchs. They're doing it subtly, under the radar. But Putin is definitely going back to the Soviet era when the state had full control of the industry," Kunhardt said.

"Russia's emergence as an economic power is tied directly to their oil reserves. But when the U.S. becomes energy independent thanks to new technologies in the shale fields, what will happen to countries that heavily rely on selling their oil like Russia? In five years, we will be a net exporter of oil. I realize that this note has a one-year time horizon only, but still. You are playing with futures contracts, and the market is already pricing the U.S. energy renaissance. We've got more natural gas than we can burn in 1,000 years in this country. All of a sudden, we're the new Middle East.

"Meanwhile you have India, which is a net importer of natural resources. What they have is a very low-cost, very educated workforce. But they have so many economic problems, including half of their population still in poverty and political tensions in their Northern border with Pakistan.

"Brazil confuses me because it has everything to be a strong regional power but it has been one of the worst-performing markets. Who else besides Canada has the mix of natural resources, a fairly educated population, scale, technical proficiency? It's a mystery to me.

"Finally, Australia is a developed country that exports to China and that has suffered a lot from its dependence on China. China's growth has slowed, and it has dramatically affected Australia.

"I remain bullish on emerging markets in general. Yields are going to stay low, even though we'll see temporary spikes in rates.

"Emerging markets over the next 18 months are going to do well, but in my opinion, not Russia, not Brazil and not India. It's not emerging markets I'm bearish on. It's those countries.

"The right structure; the wrong basket."

Kunhardt said that he was bullish on many Asian countries, including South Korea, Thailand, Taiwan, Vietnam, the Philippines and China.

J.P. Morgan Securities LLC is the agent. Distribution is through Morgan Stanley Smith Barney LLC.

The notes will price on Sept. 27 and settle three days later.

The Cusip number is 48126H357.

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