Glittering gold makes investors gleaming

Golden Opportunity: Return from gold has outperformed all other asset class in the last 1 year

Glittering gold makes investors gleaming


Gold, the shimmering yellow metal has played a pivotal role in many spheres of life for Indians since times immemorial. Be it a religious, social or financial activity, gold has been sparkling in the mind of millions of Indians. Considered as a symbol of wealth and prosperity in the Hindu religion, it plays an important part in traditional occasions like Diwali or weddings. Apart from being an object of extreme craving when worn as jewellery, gold is gaining increasing popularity as an option for investment.

However, there is a shift in the way people are investing in gold. The traditional method of buying jewellery and physical gold in the form of coins & biscuits is now giving way to a new asset class — Gold ETFs (Exchange traded funds).

Launched in India in early 2007, Gold ETFs are listed securities that can be traded like shares and are backed by physical gold holdings which are held in a vault on behalf of investors. Thanks to a runaway rise in gold prices in the recent times, Gold ETF has given handsome profits to investors in the recent months as all funds gave a return of 44 per cent in the last one year (See table). Having outperformed all other asset classes when the stock markets collapsed after the global financial meltdown, they are being increasingly seen as preferred investment options.

These instruments offer investors a means of participating in the gold bullion market without the necessity of taking physical delivery of gold. Each unit of the ETF fund is equivalent to one gram of gold, and the value of units (Net Asset Value or NAV) mirrors the price movement of gold on a particular day.

Six fund houses in India — Benchmark Asset Management, Kotak Mahindra Mutual Fund, UTI Asset Management Co, Reliance Capital Asset Management Ltd, Quantum Mutual Fund and SBI Mutual Fund — currently offer Gold ETF. Largest among them is Gold Benchmark ETF with Rs 468 crore as assets under management. Total asset under management of all six Gold ETF funds was Rs 1057.89 crore as in October 2009.

Advantage gold

There are a number of areas where investment in Gold ETF has an edge over physical gold. Being an asset which gives you the option of owning the paper form of gold, the biggest advantage is the ease of transaction. The order can be placed online or through a broker unlike buying jewellery or physical gold, where one needs to physically visit a shop.

Secondly, even though gold has been perceived as an investment option for many years, there have been concerns regarding the purity of gold in the jewellery form. Whereas Gold ETFs only pure gold from the most reliable source. As Kotak AMC Head Products Laxmi Iyer said, “The purity is assured as all the gold bought through the ETF route is approved by the London Bullion Metals Association.” Looking at it from an investment point of view, gold is an excellent portfolio diversifier. This is because it is negatively correlated with traditional asset classes like equities and bonds, and positively correlated with inflation.

Normally gold prices tend to rise when stocks and bonds do not perform well, as investors tend to seek refuge in investing in gold when the stock markets have been hit. So, it is seen as a safeguard against volatility in the stock markets. Gold also works as a hedge against inflation. When an economy is hit by rapid price rise, the value of the currency (say rupee) drops fast and investors resort to buying gold as a safe heaven. As Quantum Mutual Fund Manager Commodities Chirag Mehta said, “From a portfolio perspective, our recommendation is that 15 per cent of the portfolio should be allocated to gold EPS.” In addition to the above advantages, investors in Gold ETF have access to the wholesale price of gold.

Buying gold jewellery in a retail outlet involves a lot of additional costs that are incorporated in the price like making charges and profit margins of retailers, making it a very expensive investment option. This is not so when you purchase gold through the ETF route. Apart from these, investors benefit from another angle. Investors in Gold ETFs can book profit by selling ETF and also take benefit of long-term capital gains after one year. But it takes three years to get the same benefit case of sale of physical gold. Also, there is no wealth tax, which is applicable in case of physical gold.

Lastly, storage is not a problem as the gold is in de-materialised (dmat) form. However, Value Research Online (an online site dedicated to the mutual fund industry) CEO Dhirendra Kumar feels  that it will take time for the concept of Gold ETF to gain popularity here as Indians traditionally buy gold primarily to wear as jewellry.   

How to invest

There are two ways for investors to buy Gold ETF. One way is to route your order through a stock broker. For this, you need to have a demat account with a broker who is a member of the stock exchange. Once you have a brokerage account you can buy Gold ETF by placing an order (like a stock buying order) to buy listed Gold ETF. In addition to that, investors who have an online trading account can log in to their account and buy the product online by using the code of the product.

Mutually exclusive

People interested in investing in gold now have a choice between buying units of a mutual fund that invests in gold-related stocks or an exchange-traded fund tracking the price of gold. Even though they both belong to different asset classes, and the underlying commodity is the same, there are many differences that have to be considered while looking at an investment option.

Some mutual funds invest in equity of gold mining companies. The prices of gold mining companies reflect the fundamentals of those individual companies, in addition to the price of gold. Management decisions, a lawsuit, political risk, local currency risk and other factors can affect the valuation of gold stocks.

Also, there is the factor of market risk. So shares of gold mining companies do not necessarily move in  line with the underlying commodity and may get caught up in general market forces such as bull and bear cycles that may not actually affect gold prices. So the benefit of safety which is the inherent feature in gold investment is not passed on to the buyer.

As Benchmark Asset Management Company Private Limited National Head Sales Anil Desai said “Globally, Gold ETFs have assets of over $45 billion while funds that own gold equities have assets of about US$4 billion. Therefore, we believe there is no comparison and investors looking at getting gold exposure should look at investing only in Gold ETFs.”

Breaking barriers

To introduce the concept of Gold ETFs to investors companies had to adopt a number of strategies to penetrate the market. Elaborating on the steps Kotak had taken in this regard, Iyer said, “We conducted a number of investor awareness drives and interacted with distributors to propagate awareness and help people understand the merits of investing in gold ETFs.” The response has been as Kotak’s gold ETF has doubled its assets to Rs 80 crore currently.

Along the same lines, Quantum Mutual Fund launched an investor education programme where they addressed people through investor forums and still continue to do so. In addition to that, they made efforts to educate investors through the medium of an online newsletter called ‘Quantum Direct’.

Future looks bullish

Analysing the reasons why a weak dollar may push up gold prices, Mehta of Quantum said, “According to me, there is currently a lot of debt in the US economy. If you see the Congressional Budget office estimates, it shows that the deficit is likely to go up. There is a strong possibility that over a longer term the dollar will depreciate more, so it is likely that gold will increase in value.”

Mirroring the optimism, Iyer said, “I think a lot of decoupling is taking place between gold and the dollar. Even though it is too early to call it a trend, my opinion is that if the central banks across the world need to diversify their foreign exchanges asset the price of gold would move upward irrespective of the movement of the dollar.”

It is not free of risk

Despite several advantages, no one should assume that investing in Gold ETF is risk free. Like all other asset classes where prices are market determined, investment in Gold ETF can also lead to loss of money. As returns are linked to the international price of gold, the NAV of Gold ETF schemes can fall with the international price of gold, which, in turn, is dependant on a number of factors over which Gold ETF funds have no control.

Also, there is no option of diversification of portfolio as the entire investment here is in gold. Also, it should be seen that when investing in a mutual fund, the investor can rely on the expertise of a fund manager who indulges in active portfolio management and is able to take crucial decisions in selecting stocks. But this not the same with gold ETF.



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