HSBC’s $253,000 buffered leveraged notes on gold miners may be riskier than pure gold bet

By Emma Trincal

New York, July 9 – HSBC USA Inc.’s $253,000 of 0% buffered Accelerated Market Participation Securities due July 6, 2023 linked to the VanEck Vectors Gold Miners ETF combine the risks of two different asset classes: stocks and commodities, said Clemens Kownatzki, finance professor at Pepperdine University.

If the fund return is positive, the payout at maturity will be par plus 200% of the fund return, capped at par plus 26.65%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the fund falls by 10% or less and will lose 1% for every 1% decline beyond the 10% buffer.

“The underlying is an equity fund of gold mining companies. But the correlation between the miners and the precious metal is obviously quite strong since mining companies see their profits rise with the price of gold,” said Kownatzki.

“When you get exposure to this ETF, you have exposure to stocks but also to a hard asset, at least indirectly.”

Gold prices

He looked at gold prices first.

With inflation rising and real interest rates still negative, Kownatzki said he would have expected the precious metal to rally.

But it hasn’t been the case for the past year except in May when gold rose 8%. While gold has moved slightly higher in the past month, its price remains below the level recorded at the end of May.

In the past year, gold prices have declined. The precious metal is in correction territory, trading at $1,809 an ounce on Friday, an 11% drop from its August high of $2,028.

“It’s been a difficult time for gold, and it is a little bit of a surprise given that it’s one of the few assets that doesn’t lose value in an inflationary environment. With inflation rising, you would have expected gold to do well as a hedge,” he said.

“The government has been injecting liquidity in the system and real interest rates are still negative. Gold prices should have rallied. But it hasn’t really been the case.”

New attitudes

Kownatzki said some fundamental issues are at play as investors have changed their view on the precious metal.

“There’s been a switch in the way investors, particularly younger ones, are looking at gold,” he said.

“Traditionally, people turned to gold in times of economic uncertainty. It was a hedge against inflation and perhaps, an even better hedge against recessions because it is a hard asset.”

Between 2008 and 2012 when global markets endured bouts of inflation, and the market crash of September 2008 followed by the financial crisis and the ensuing European sovereign debt crisis, gold more than doubled in price, asserting its value as a safe haven.

“Now it looks like investors have shifted from gold to something else,” he said.

Crypto rush

The “something else” is almost a function of the age of the investor, he added.

“For traditional investors, Treasuries seem to be the preferred flight to safety. It’s possible that assets may have shifted from gold to government bonds, which are the traditional safe haven.”

But another and perhaps more important factor playing against gold can be traced to a younger type of market participant.

“Some investors, especially those who use the Robinhood platform, are extremely bullish on Bitcoin. The appeal of digital currency probably plays against gold. Part of the money, which would normally go to gold, is shifting to digital assets. That’s the biggest headwind,” he said.

Equity risk

In this context, Kownatzki compared the underlying gold miners ETF with the precious metal asking whether one would be better than the other in today’s market.

While answering this question was not easy, he indicated that a play on the commodity may be preferable for investors.

“The gold miners ETF is often seen as a commodity play. But its equity components mitigate the attractiveness of a hard asset,” he said.

“On the one hand, the stock market is rallying courtesy of the Fed’s accommodative policy and asset purchases.

“As long as the Fed continues to inflate asset prices, gold miners will benefit like most equities.”

“But the market remains vulnerable to the Fed’s tapering and to inflation.”

Bottlenecks

Another risk for companies involved in mining gold is the post-pandemic issues adversely impacting the industry.

As with other sectors of the economy, gold miners are suffering from supply constraints, he said.

“During the pandemic, some of their workers have been staying home due to the lockdowns or some got sick. It created logistics issues,” he said.

In the current post-pandemic environment, new problems have emerged, he noted.

“Companies may not be able to hire new people. Former workers may not want to go back to work for the company. They may have found jobs elsewhere. Or they may lack the incentive to work due to the extended Covid-19 unemployment benefits. This creates human resources problems, labor shortages problems. The result is bottlenecks and supply shortages,” he said.

Not a real diversifier

Another potential headwind for the VanEck Vectors Gold Miners ETF is its high correlation with the S&P 500 index, he noted.

“If you buy this ETF for its relatively low correlation to risky assets, it doesn’t do the job,” he said.

“The correlation between miners and the S&P is low. Worse: it’s not very stable. It’s been moving all over the place from positive to negative and very quickly.”

As a result, the gold miners ETF may not be the best hedge against a market pullback and/or inflationary pressures, both of which have proven to possibly coexist.

Reasonable structure

The structure of the notes however appeared attractive, he said.

“The double upside is good. The 26.65% cap is realistic based on historical performance.

“Of course, we don’t know what the next couple of years will look like. But I can’t imagine the ETF closing above the cap in two years, not with equity valuations being as high as they are in this late stage of the equity cycle.”

The main drawback, he said, was the downside protection.

“It’s always good to have a buffer but I’m not sure 10% is enough,” he said.

“If we have a dramatic decline in the stock market, this ETF could lose a lot more than 10%.”

Commodities alternative

In conclusion, Kownatzki said a note linked to the hard asset would be a better play than a bet on gold miners.

“The VanEck is not a physically backed gold fund. It’s a stock fund whose share price moves with the price of gold. There is an equity component and a commodities component.

“As an investor, you’re exposed to the risks associated to both asset classes.

“The risk with gold is the shift to bitcoin and the use of alternative safe havens. But the stock market is overvalued and betting on an equity fund in this toppish market probably exposes you to a greater risk.”

As an alternative, he would bet on the SPDR Gold Shares, an ETF giving direct exposure to the bullion.

“A pure gold play despite the risks with gold would at least remove the equity risk. It seems like a more prudent alternative at this time,” he said.

HSBC Securities USA Inc. is the agent.

The notes settled on July 6.

The Cusip number is 40439JBS3.

The fee is 0.5%.

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