Wednesday, March 7, 2012

Are South Africa's new platinum and silver ETNs exciting?

South Africa's ABSA bank plans to launch platinum and silver Exchange Traded Notes (ETNs). Will they prove to be as successful as the country's New Gold ETF?

JOHANNESBURG - Fresh off the end of a costly six week strike at Impala platinum's Rustenburg operations, investors may be scouting around for exposure to the platinum price without the concomitant risks of mining the metal.

If so, then Absa's NewWave Platinum Exchange Traded Note (ETN) due to list in South Africa next week may prompt some interest.

Warren Ingram, director of Galileo Capital, agrees that investors seeking exposure to the shiny metal would be looking at the platinum notes.

"If you look at the NewGold ETF [exchange traded fund] as a proxy, it is one of the most successful ETFs on the exchange, and then I think it [the platinum note] is a great instrument and I think that most people who have a more positive long term outlook about precious metals would look at them" said Ingram.

Besides the labour issues, platinum producers are facing increased safety stoppages, rising electricity costs, threats of expropriation in Zimbabwe and increased mining taxes.

This is all likely to put pressure on supply and potentially drive up prices should demand stay intact. Platinum has increased from just under US$1400/oz to over US$1600/oz in the last three months.

"It is true that the notes take out some of the risk variables like the strikes and bad company management. An adverse effect on the mine could help increase the metal price" said Ingram.

"I'm not a massive fan of holding any of the physical commodities but there is more logic in holding platinum than gold due to its industrial uses" added Ingram.

Dr Vladimir Nedeljkovic, the head of investments at Absa Capital, confirmed that the platinum and silver notes are to be launched in a bid to create investment products similar to the NewGold exchange traded fund (ETF). In addition to the commodity ETNs, the bank will also be listing three currency notes (GBP, Euro and USD).

The NewGold ETF has attracted interest from investors similarly looking for exposure to the gold price without the risks attached to South Africa's deep level gold mines.

Absa Capital's precious metal notes differ from similar products currently offered in the South African market as they track the spot price of silver and platinum, and not their futures price.

Apart from the normal risks associated with investment in commodities (price risk and the Rand/USD exchange rate risk), investments tracking futures prices introduce an additional risk intrinsic to such instruments - the roll risk. Platinum and silver futures prices have underperformed the spot prices of the metal by about 0.5% annualised over the last five years said Nedeljkovic.

ETN vs. ETF

"There is one key difference between an ETF and an ETN. An ETF is a ring-fenced vehicle holding underlying assets (similar to a unit trust). Investors in ETFs are not exposed to any credit risk as their investments are backed by the underlying assets. ETNs are notes issued by a bank and backed by the strength of its balance sheet" said Nedeljkovic.

In this particular case Absa will be purchasing the underlying assets to hedge its exposure with respect to the notes issued.

Nedeljkovic also pointed out that the platinum and silver ETNs differ from the NewGold ETF in that they are not classified as a domestic asset. This means that institutional investors would have to account for any investment in them as part of their offshore allocation.

Liquidity and Demand

Based on the experience with the NewGold ETF, demand is expected to come mainly from the institutional investors. Despite this there isn't a minimum amount that limits entry. "You can even buy R100's worth" said Nedeljkovic.

There is also no time limit or holding periods attached to the instrument.

Absa received applications totalling R13.9m for its platinum notes at an initial issue price of R128.53. This price was determined as the Rand equivalent of the spot USD price of one-hundredth of a troy ounce of platinum on 2 March and equates to 108 308 platinum notes to be listed on the JSE's main board.

Interest or dividend income

One of the downsides of the commodity ETN is that they do not generate an income stream in the form of dividends like their equity counterparts.

"The negative side of the notes is that there is no chance of earning an income from that investment if it goes down whereas with a mine that is still profitable during the tough times you may still earn dividends - that is one of the reasons I don't recommend physical commodities" said Ingram.

Not unlike equities there is no capital protection for the commodity notes.

"If the resource cycle takes a dip - then you will have bad returns from the ETN. If you look at the prices of gold and platinum over the last 30 years they are close to historical highs" warned Ingram.

Costs

The fees attached to the commodity notes is 0.4% per annum on the total capital invested which is accrued daily so if you were to invest R100 for a year then the fees would be 40c.

There is also a 1% redemption fee or creation fee should you do block trades directly with Absa and not via the JSE. "This is not applicable to the vast majority of investors. Our experience with NewGold is that it will be almost exclusively traded on the JSE" said Nedeljkovic.

Future plans

Besides investing in the ETNs on the JSE via your stockbroker, ABSA is planning to put the notes into investment plans where you can invest via a debit order facility similar to unit trust investments.

Source: Mineweb