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Invest In Gold the Smart Way - Outside View by PersonalFN
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Invest In Gold the Smart Way
Jun 5, 2014

The importance of gold in one's portfolio cannot be understated, and for India gold over decades has been looked as traditional safe haven, making a currency of choice. In our country people buy, this precious metal on and for various occasions such as religious festivals, marriage etc. which pulls the demands for this yellow metal. But along with the demand, there are various factors which affect the price of gold.

Historically gold prices are determined by a combination of political and economic factors. However, in the past few years the other major factors which affect the prices of gold are as under:

  • Weak U.S. Dollar:

    As long as buying interest is seen in the U.S. Dollar, the dollar generally remains strong, which refrains gold prices from making any significant up-moves. However, once the US Dollars are dumped (sold) or buying interest in the dollar mellows, it weakens the dollar, thus turning investors' attention towards the safe haven gold. Infact during such scenarios most countries also accumulate more gold, thereby increasing their gold reserves.

  • Economic turmoil:

    Whenever the global economy suffers the pain of an economic crisis, heads turn from "equity" to "gold", which thus makes prices of gold move up; thus indicating that investors' take refuge in this safe haven.

Also today for investing in gold, investors have various options. They can invest in the old-fashioned physical form, Gold Exchange Traded Funds (Gold ETFs) and/or also invest in equities of gold mining companies, through gold mining funds.

Our experience speaks that, very often investors get lured by escalating gold prices and invest in the yellow metal mostly by buying physical gold, without really evaluating the pros and cons offered under each mode/option of investing in gold.

Here are various options for investing in gold investing:

Physical Gold

If you are an hardcore believer of investing in physical gold, the only advantages which it can offer you is "touch, feel and see" along with the choice of converting the gold coins and bars collected by you; into jewellery at some point in time. However, this passion of investing in gold in the physical form has some disadvantages which are as under:

  • Holding cost:

    Yes, we often don't evaluate that holding gold in a physical form, comes at a "holding cost". Holding cost refers to the cost of holding a security. Hence, the locker rent which one pays for stacking gold in the bank locker constitutes to be the holding cost.

  • Quality:

    Unless the gold which you buy is from a reliable source, the quality of the same is always under question, thus resulting in your precious asset losing its true value.

  • Premium:

    Very often jewellers and banks sell gold coins and bars at a premium, to the market price. The premium is usually in the range of 5% - 10% (inclusive of making charges) in case of jewellers and upto 15% in case of banks. So, in that sense the pricing of gold varies depending on the vendor.

  • Resale Value:

    While selling your physical gold, you must have encountered some horrendous experiences of your gold merchant telling you "this is not 100% pure it has some mixing", thus questioning the quality of the gold held by you. Moreover, if the quality of the gold held by you, is of the finest purity, then while converting gold into jewellery making charges are deducted. And as regards the banks are concerned they will refuse to buy-back your gold.

  • Tax:

    If you are gold bug, then you would also be axed by wealth tax.
Gold ETFs

For gold bugs, investing in Gold Exchange Traded Funds (GETFs) today is a very simple and a lucrative exercise.

So, what is Gold ETFs?

Before understanding GETFs, let's first understand what is meant by Exchange Traded Funds (ETFs). ETFs are instrument, offered by mutual fund houses and are listed on a stock exchange. They represent ownership in an underlying security, commodity or asset. Hence, now to simply put, a GETF is an instrument that represents an ownership of gold assets. This gold is held on your behalf by an appointed custodian for the ETF.

When you buy a GETF, you get a contract indicating your ownership in gold equivalent to the rupee amount of your investment. They are open-ended funds which track prices of gold, and each unit of gold in the fund that you can buy, is equal to 1 gram of gold (some fund houses also offer 1 unit at 0.5 gram of gold). However you will never get to see or receive delivery of the gold you own you will only have a contract that represents your ownership interest.

GETFs are listed and traded on a stock exchange and hence can be bought and sold like stocks on a real-time basis. But to own them you need to open a demat account along with a share trading account with your broker. While transacting in GETFs, you would be required to simply call your broker and place your orders (at the prevailing market price), or do the same with the online trading application provided by him (broker).

So, now one may ask - what's the advantage if I can't touch, feel and see the precious yellow metal? Well, GETFs offer a host of benefits which are as under:

  • Convenience:

    GETFs are a convenient means of investing in gold because there's no question of physical delivery. Hence, you do not have to worry about the storage and security aspects that are typically associated with investing in physical gold.

  • Quality:

    You don't have to worry about the quality of the gold which you hold; because as per the Securities and Exchange Board of India (SEBI) regulations, the purity of underlying gold in GETFs should be 0.995 fineness and above.

  • Premium:

    We are sure that you must have encountered the horrendous experience of the gold vendor charging a premium at the time of your purchase of physical gold. However, this does not happen in GETFs as transactions take place at the prevailing market rates, without paying any premiums. Hence, the pricing in GETFs is transparent.

  • Low cost:

    To store physical gold, you would typically need a locker. And as you may be aware that a locker rent comes at a cost. Hence the holding cost which you incur in the form of locker rent, are completely done away with. The only cost you would have incur for holding GETFs is the cost of maintaining your demat and trading account with a broker, and the nominal brokerage for each transaction. Finally, there are annual recurring charges which are charged to the fund.

  • Resale value:

    Unlike physical gold, GETFs can be easily sold in the secondary market on a real-time basis (i.e. at the prevailing market price). Whereas, while selling physical gold, the jeweller will deduct making charges (the charge that is added while buying gold). As regards banks, they refuse to buy back gold.

  • Taxation:

    Tax implications on GETFs are same as those on debt mutual funds. A unit of a GETF that is held for less than twelve months is treated as a short-term capital asset. Gains on the same are taxed at your marginal rate of tax (i.e. as per your income slab). Units held by you for more than twelve months are treated as long-term capital assets, and would be subject to long-term capital gains tax at 20% (after allowing for indexation benefit) or 10% (without indexation benefit), whichever is less.
Moreover, you do not have to bear the burden of Wealth Tax if you invest in GETF.

Gold Savings Fund

Gold Saving funds (also known as "gold funds"), is relatively a new breed to invest in gold regularly. Gold Saving funds are generally fund of fund schemes which invests their corpus into an underlying Gold ETF which benchmark their performance against the physical prices of gold. Hence by doing so, they attempt to provide returns that closely correspond to the returns of its underlying Gold ETFs.

Even though "Gold Saving funds" are passively managed, the most wonderful thing about them is that, they provide you the opportunity to invest in gold without really having to worry much about how to store it physically, since units are allotted to you. But here, unlike Gold ETFs (where you hold units in your demat account); in gold funds you are allotted with units of the fund in a paper form (it reflects in the mutual fund account statement).

The annual expenses charged by Gold Savings funds may be comparatively higher than what is charged for Gold ETFs, as it includes the additional fund management cost along with the cost of Gold ETFs. Thus investors having a demat account, may find it cheaper to buy Gold ETFs instead of applying in this fund. However for investors not having demat account, gold funds may be cost effective investment option for investing in gold in a paper form, because here you do away with the annual charges of holding a demat account (which you incur while holding Gold ETFs). Moreover, gold funds apart from lump sum investing, offer the Systematic Investment Plan (SIP) mode, which is effective and convenient way of investing regularly in gold.

World Gold Mining Funds

Investors also live under impression that by investing in gold mining funds, they'll be able to bet on the movement of gold prices. Well that's not the case!

Gold mining funds are feeder funds that invest in offshore funds investing in stocks of gold mining companies. The investments in gold mining fund is linked to both gold price movements and volatility in equity markets, as these funds bet on stocks of gold mining companies.

These funds are highly correlated to equity markets and relatively less correlated to gold price movements. So, when equity markets perform well they too perform well. Hence, these funds are suitable only for those investors' who have a high risk appetite.

Our View:

We believe that Gold ETFs and Gold Saving funds are a smart way for investing in gold, for the advantages they offer. However, if one wants to take advantage of both equity as well as gold and, has high risk appetite then gold mining funds can be considered. But, please don't be under the illusion that by investing in gold mining companies' fund, you are betting on the gold price movement completely.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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