Barclays' notes tied to gold use barrier, cap to overcome pricing challenges, meet high demand

By Emma Trincal

New York, Sept. 7 - Barclays Bank plc's 0% notes due Sept. 20, 2012 linked to the performance of gold are a response to growing demand for the precious metal, sources said.

But given the unprecedented highs reached by the spot price of gold this year, structured notes directly linked to the metal are difficult to price, leading issuers to either use substitute assets or introduce structural twists that make the product more attractive.

The choice of a cap and a barrier, rather than a buffer, illustrates how Barclays is trying to make a structure work despite the cost of the embedded options, a structurer said.

If the final price of gold is greater than the initial price of gold, the payout at maturity will be par plus the gold return, subject to a maximum return of at least 21.88% that will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

Investors will receive par if the price of gold declines by 20% or less and will be exposed to the decline from the initial price if the price of gold declines by more than 20%.

Barrier vs. buffer

"Using a barrier will give you a better risk/return trade-off," the structurer said.

"You'll get either more upside or a better cushion of protection than if you had a simple buffer."

With a 20% barrier, a decline in the price of gold at maturity by more than 20% from the initial price will trigger a loss of capital equal to the percentage decline, which could wipe out the entire investment, according to the prospectus.

On the other hand, a 20% buffer would guarantee at least 20% of downside protection. The investor begins to lose principal from the strike price, 80% of the initial price, instead of from the initial price.

"You have to compare apples with apples. A barrier will give you either more upside or more downside protection," the structurer said.

"All things being equal, you wouldn't replace a 20% barrier with a buffer of the same amount. It would be more like 10%."

The cap of nearly 22% for a one-year term was also introduced to facilitate the pricing of the deal, the structurer said.

"A buffer would have given you a lower cap than that."

On the rise

The price of gold has risen by 35% this year to a record of $1,921 on Tuesday from $1,421 on Jan. 1.

Deals linked directly to the spot price of gold have started to increase this summer, according to data compiled by Prospect News.

In the first seven months of the year, agents priced $129 million in 18 deals using the price of gold.

Since Aug. 1, so a little bit more than a month, firms have sold eight deals tied to the gold spot price totaling $50 million, according to the data.

Substitute underlyings

Because the price of gold has rallied so much, options on gold have risen, making the pricing of those products very challenging, said a sellsider.

Many of the offerings giving investors access to gold are structured around exchange-traded funds such as the Market Vectors Gold Miners ETF or stocks such as Barrick Gold Corp. and Freeport-McMoRan Copper & Gold Inc., according to data compiled by Prospect News.

"Gold option prices to play into structured products are expensive right now. You have to put caps. You have to limit protection," the sellsider said.

"But interest for gold is off the chart, and everyone in retail wants structures tied to it. Every issuer is looking at ways to do that.

"Demand for gold ETFs is huge, but ETFs don't have downside protection. If it pops, you're in trouble.

"The banks are looking at this demand for ETFs, and they see structured notes as a good alternative."

The notes (Cusip: 06738KUN9) are expected to price Sept. 9 and settle Sept. 14.

Barclays Capital Inc. is the agent. JPMorgan Chase Bank, NA and J.P. Morgan Securities LLC are dealers.

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