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For centuries, human communities have used gold as money and standard of value. Recently it began to be traded in exchanges through the Gold Exchange Traded-Fund or GETF. But investors are yet to consider it a serious investment option. The gold ETFs are delivering 8 percent returns since August, despite Sensex showing extreme volatility.
The trend is expected to continue for a couple of months. But that hardly moves investors. Confusion, lack of knowledge and unpredictability are some reasons for gold ETF not pickling up as an investment option in India, market pundits say. The idea of gold ETF was first officially conceptualized by Benchmark Asset Management Company in India when it filed a proposal with the SEBI in May 2002.
However, it did not receive regulatory approval and was only launched later in March 2007. The first gold exchange-traded fund actually launched was in March 2003 on the Australian Stock Exchange.
The idea is to give investors the ability to own gold and make profit from the price variation, without the inconvenience of storing actual gold. Market experts say people investing in gold ETF should think differently from other commodity investors. One shouldn't judge gold ETFs on the performance parameter. It must be perceived as an asset class and a hedge against currency fluctuations.
Know the game
Gold ETF typically is an exchange-traded mutual fund listed and traded on a stock exchange. Gold is the underlying asset for the units of that fund. Every unit of that fund represents a small quantity of pure gold and the traded value of that unit moves in tandem with the price of gold actual market. Normally, a mutual fund company launches gold ETFs.
Any mutual fund company launching such as fund appoints authorized participants (APs) who buy the units of gold ETF from the mutual fund by exchanging actual pure gold for the units they buy. These APs facilitate secondary market through the stock exchange, where investors can buy or sell gold units on payment, for quantities as small as one unit. The gold is held by the mutual fund company. Authorized participants can go back to the mutual fund house to redeem the gold ETF units in actual pure gold at any time.
Why invest in paper gold?
Investing in gold ETF helps an investor avoid all the disadvantages of investing in physical gold such as the cost of storage, liquidity and issues of purity. Gold ETFs conform to rigid regulations on investment and assures 0.995 purity of gold. And then, gold ETF allow investment in gold in small denominations, helping the retail investor to participate. Shares are sold in gold units of approximately one gram. This enables the investor to accumulate units, benefit from coast difference.
The units can be redeemed either from the fund directly or from the market. Besides, it gives investor tax advantages. Capital gains in gold ETF units are tax exempt if held for more than one year, whereas capital gains in physical form is exempt from tax after three years. Also, investment in gold FTF is not subjected to wealth tax. Stability, reduced volatility, inflation-plus returns and convenience are also all good reasons to invest in gold ETFs.
Consider that you need 100 grams of gold your daughter's marriage three years from now. Investing in gold ETF is your best option. It would be better than saving money to buy gold three years later or accumulating small amounts of physical gold over the period. Here is how. Suppose you invest in gold ETF each month buying three units (equivalent to 3 grams) of paper gold, at the end of three years you would have little over 100 grams. The money you spent over the years would be less than the market value of that amount of gold, at that time. But if the gold price goes up every year, your savings would be greater. In that respect, a gold ETF seems to be a safe option for even an ordinary individual.
Market and gold trends
All those who have been watching precious metals in India know that they have high and low seasons. During the festival season that peaks in October-November demands for gold increases, pushing the price up at least marginally. But market experts say at long term the gold prices are going to get stabilized for a number of reasons. For one, it has already shown an upward trend reaching its peak.
Hence, it a good time to trade; buy at low in off-season and sell high in season. Internationally, gold demand is marginally higher than the supply. Since no new mines are being allotted, slowly demand-supply gap will increase. But on individual level, the demand for gold is coming down.
More and more people prefer mixed and unauthentic ornaments and take less pride in owning pure gold. That pulls down the demand for gold. Also, the rich prefer more expensive materials such as diamond and platinum. Besides, the new fashion trends look down upon people wearing high coast ornaments. All put together would mean gold prices have stabilized, market pundits say.
Inherent risks
One basic problem that small investors may face is of converting the units into cash. At a time of crisis, one may not find buyers ready to give a fair price. Redeeming units directly from the fund may not be an option available. During periods of financial crisis like hyper-inflation or failure of banks, the large investors may convert their units to physical gold; small investors may find it difficult to do that.
Gold ETFs returns may be god for short term, but their long term returns may not be very encouraging. An investor must not rule out the fund management cost involved in an ETF, which however low, reduces the returns to a certain extent. An investor may consider buying the units in the secondary market, where brokerage costs may be lower. Despite all the risks involved, if an investor is convinced of the reasons to invest in gold and knows the market dynamics, gold ETF may be the ideal vehicle for him to ride to prosperity.
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