Citi’s autocall contingent coupon notes on metal ETFs offer high income in rangebound market

By Emma Trincal

New York, May 13 – Citigroup Global Markets Holdings Inc.’s market linked securities autocallable with contingent coupon and contingent downside due May 30, 2024 linked to the worst performing of the VanEck Vectors Gold Miners exchange-traded fund, the iShares Silver Trust and the SPDR S&P Metals & Mining ETF provide an attractive yield, but as commodities prices and inflation are surging, bulls hesitate to monetize volatility for income while more cautious investors are reluctant to get exposure to the volatility of the underlying assets.

The notes pay a contingent quarterly coupon at an annualized rate of 12.5% to 14.5% if each ETF closes at or above its coupon barrier level, 70% of its initial level, on the valuation date for that period, according to an FWP filing with the Securities and Exchange Commission.

The exact coupon rate will be set at pricing.

The notes will be autocallable at par plus the contingent coupon if each ETF closes at or above its initial price on a quarterly observation date.

If the notes are not called, the payout will be par unless any ETF finishes below 70% of its initial level, in which case investors will lose 1% for every 1% that the least performing ETF declines.

Post-Covid mess

Commodities trader Matthew Bradbard, director of RCM Alternatives, said he is bullish on metals. The existence of a coupon capping the gains and the long-term holding period would dissuade him from investing in the notes.

“Commodities in general will see higher prices in the next two years. It’s already happening but we’re in the second inning,” he said.

“Agricultural prices have moved significantly higher, oil doubled in the last six months, metals are definitely on the rise.”

The post-pandemic environment is at the origin of a commodity rally with economies reopening and more spending.

“Distribution was put on hold. Now demand is coming back. Prices go up. It’s supply and demand. With Covid we had a lot of shipping issues and we could have a lot more,” he said.

Bradbard said he does not see the situation as transitory.

“Those unbalances between supply and demand are not going away. Futures prices are rising, and I don’t think it’s going to be a short-term trend,” he said.

China, diversification

The growth of China was another factor behind the rally.

“China is the biggest consumer, the biggest player. There are a lot more people trading,” he said.

Finally, after a long eclipse, commodities are making a comeback in the portfolios of U.S. investors.

“A lot of investors are now buying commodities ETFs like SLV or equity funds based on commodities like GDX and XME because the stock market is at record highs. They’re using these funds to move money out of equity for fixed-income replacement and diversification. Even if GDX and XME are equity funds, they are directly tied to futures markets,” he said.

He was referring to ticker symbols – “GDX” for the VanEck Vectors Gold Miners ETF, “SLV” for the iShares Silver Trust and “XME” for the SPDR S&P Metals & Mining ETF.

CPI bombshell

But the biggest long-term driver for rising commodities prices is inflation.

“Inflation is up and is going to continue to go up. Unfortunately, the way they measure it makes no sense. We eat food and consume energy.”

He was referring to the core inflation rate, or Consumer Price Index, which measures the price of everything except energy and food.

The spike of core inflation alone shocked the stock market. The CPI rose 0.9% in April, its largest monthly increase since April 1982. The news announced by the U.S. Bureau of Labor Statistics on Wednesday precipitated a sell-off.

The rise of the price of Bitcoin is also a sign of growing inflation as much as speculation. Some analysts see this new asset class as potentially rivaling with gold as a substitute to hedge against currency depreciation and inflation. Asked whether this could be a risk for gold, Bradbard answered negatively.

“Bitcoin is now trading on the exchanges. There’s more participation, which is good. But there’s room for both,” he said.

The CME Group provides cryptocurrency exposure via futures.

High valuations

Although bullish on metals even for the two- or three-year-time horizon, Bradbard said the underliers in the notes could show some volatility.

“The structure doesn’t let you capture big moves both on the upside and downside. Your returns are capped. And the 30% protection is not enough,” he said.

The prices of the underlying securities are already high, he added.

The SPDR S&P Metals & Mining ETF for instance hit a 52-week high on Monday. Others like the Silver Trust are near the top.

“You’re coming late in the party, with silver especially.

The Silver Trust traded at $14 a share a year ago. It closed at $25.16 on Thursday, gaining 80%.

Contango

The Silver Trust ETF is also indirectly subject to contango risk, a negative phenomenon eroding the return of long futures positions.

A futures market is in contango when current contract prices are lower than future prices, which makes the cost of rolling the contracts at expiration more expensive.

The Silver Trust, which does not hold or trade in commodity futures contracts but instead only invests in silver bullion, should not in theory be directly impacted by contango. But contango does impact the price of silver on the futures market.

“Silver is in contango. The ETF is a broken instrument,” he said.

Volatility, correlations

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said he was not comfortable with the choice of underliers.

“I don’t follow the metals particularly, but I know that these miners can move a lot up or down. So, there’s a fair amount of volatility in this type of trade,” he said.

Since the payout is a worst-of, the relatively weak correlations between the underliers adds another layer of risk, he noted.

“They’re all miners but from different commodities and asset classes,” he said.

The SPDR S&P Metals & Mining ETF and the VanEck Vectors Gold Miners ETF display the weakest correlation at 37.9% on a scale of 0 to 100% on a three-year timeframe.

The SPDR Metals fund and the Silver Trust post a 48% correlation to one another. The Silver Trust and the VanEck Gold Miners are the most closely tied at 63.7%.

But those correlation levels pale compared to those between blue chip indexes such as the Dow Jones industrial average and the S&P 500 index, which have a 0.98% correlation to one another.

Medeiros said that using structured notes for yield is a good idea in general.

“People are getting more and more creative to find income because of what the rates are right now. In general, having some sort of protection associated with income is attractive,” he said.

“But in this case, the miners are too volatile for me even though the double-digit coupon is definitely appealing.

“The 70% barrier may or may not be enough. I wouldn’t underestimate the risk of breaching the barrier.”

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the underwriter. Wells Fargo is the agent.

The notes are expected to price on May 27 and settle on June 2.

The Cusip is 17329FNZ3.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.