Scotiabank’s autocalls on gold miners ETF show good timing ahead of inflation, contrarian says

By Emma Trincal

New York, Aug. 30 – Bank of Nova Scotia’s 0% market-linked securities – autocallable with fixed percentage buffered downside due Sept. 6, 2022 linked to the VanEck Vectors Gold Miners ETF give investors a decent chance to capture the gold rally before it ends, according to Steven Jon Kaplan, founder and portfolio manager of TrueContrarian Investments.

The investment is providing good timing for a delicate bet as gold rallies are difficult to predict and are usually short-lived, he said.

The notes will be automatically called at par plus a call premium of 9% to 10% per year if the ETF closes at or above the initial index level on any annual call date, according to a 424B2 filing with the Securities and Exchange Commission.

If the notes are not called and the final index level is at least 90% of its initial level, the payout at maturity will be par.

Otherwise, investors will lose 1% for each 1% decline of the index beyond 10%.

Value

When assessing a structured note, Kaplan looks at the value of the underlying, carefully avoiding funds that are too popular. As a contrarian, he seeks out-of-favor assets in order to buy at a bargain price as long as his perspective is bullish.

Gold does not neatly fit into this profile as the precious metal has already began to rally. But Kaplan believes there is room for further growth.

Timing is also a very important factor in his investment decisions.

“In this case, the structure is interesting,” he said. “I wouldn’t buy into a three-year. But this note can be redeemed with a premium after just one year as long as the ETF stays flat or goes up.

“It can be done, I think. You get out with your 9% after one year.”

Timeframe

The one-year timeframe is “just right,” because investors have started to buy gold only recently.

The gold rally began last fall. The underlying fund, which tracks the stocks of gold miners, dropped in the early spring to hit a recent low of $20 per share in May. The fund is now trading at around $30.

One factor likely to end this rally is the start of a recession. But Kaplan does not see the risk of a recession as imminent.

“I don’t think we’ll hit a recession a year from now but we’ll be close,” he said.

Once a recession happens, the gold rally will be over, he said.

“That’s when people cut back in assets they don’t need, and that includes gold. I think there’s enough time to make that call a year from now,” he said.

Equity bear market

Kaplan however believes U.S. stocks are in the early stages of a bear market.

That’s because the Russell 2000 is still down 14.2% from its previous high of a year ago and has not recovered since. Meanwhile the S&P 500 and the Nasdaq are still near their all-time highs, he explained.

“Small-caps are always a good leading indicator. This divergence between large-cap and small-cap is typical of a nascent bear market. It’s been seen in 1972 and also in 1929.”

Gold will turn more attractive when investors begin to worry about their returns. Big intraday swings in the market can become discouraging for long-term investors.

“We already have that kind of volatility. Trump has encouraged uncertainty. The U.S. economy is growing more slowly than it did last year,” he said.

Gold will rally even further once investors begin to face up to reality, said Kaplan, who studies investors’ behavior as part of his investment strategy.

“We are in a bear market already. Investors are unwilling to admit it. They’re piling on money in trades that are overcrowded. The S&P is overbought. People buy the same stocks over and over,” he said.

Irrational bid

It’s also true in the fixed-income space. Case in point: investors feasting on U.S. treasuries.

“People feed into this media obsession about the recession,” he said.

“It’s the classic flight-to-safety. But it’s a herd-like instinct.”

The heavy bid on long-term Treasuries is “puzzling,” he said, given that the real yield – nominal yield minus inflation – is negative.

What’s bad news for bond buyers is good for gold.

“For one of the relatively few times in history U.S. real interest rates are negative. This has only happened a few times, including 1979, and it is very positive for precious metals, including gold,” he said.

“What is also bullish for gold is that real government bond yields are also negative in many other countries and their governments are eager to see them becoming even more negative,” he said.

Gold, often criticized for paying no interest, benefits from negative bond yields.

Watching the unseen

Gold bulls will benefit from the resurgence of inflation as the precious metal is a proven inflation hedge.

Kaplan as a contrarian investor said he pays attention to signs of brewing inflation at a time when the market is “obsessed” with recession fears.

“Inflation is not visible right now,” he said.

“But there is a misplaced fear about the risk of a recession. We’ll have one, for sure. But not before the end of next year.”

And not before inflation makes a comeback.

“This pattern has existed for centuries: inflation first, recession second,” he said.

For now, one has to look carefully to notice signals of rising prices. Inflation has been running below the 2% objective set by the Federal Reserve for most of the year.

But Kaplan looked at previous inflation/recession cycles.

“Inflation surged in 2007 as the Russell went into a bear market and prices kept on going up until the summer 2008. In 2007, who would have thought we would have such a severe recession a year later?” he said.

The “Great Inflation” that began in late 1972 also preceded the 1973-75 recession, he said.

Smart money

Another subtle sign is what insiders are buying right now.

Sophisticated investors “in-the-know” are currently buying commodities-related assets, which will benefit from rising prices. Conversely, they are selling high-dividend stocks and utilities whose value suffers from inflation.

For Kaplan, investors are downplaying the risk of inflation simply because it has not happened in a decade.

“All the elements behind a short-term rally in gold are combined,” he said.

The notes, according to his macro-economic outlook, should benefit investors.

See you in one year

“I expect to see people moving their money into gold but not for another year. That’s when the first call in the notes will be handy. You’ll get out at 9% and that’s a good thing. Gold rallies don’t tend to last very long. Having a chance to lock in a 9% to 10% profit in one year seems relatively attractive,” he said.

Kaplan does not see the memory of the call premium (cumulative payout) as being used although it is helpful.

“I think a call after 2020 is unlikely because we will probably enter a global recession prior to or coinciding with the U.S. Presidential election in November 2020. So, by 2021 we will be deep into a recession and gold will be down sharply along with most other assets. Gold could even peak in less than a year, perhaps in the spring of 2020,” he said.

“This is a good strategy. I think the timing of the first call plays out in your favor.”

Scotia Capital (USA) Inc. and Wells Fargo Securities, LLC are the agents.

The notes will settle on Sept. 5.

The Cusip number is 064159PR1.

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