Gold Miners or Gold Bars

Investing in Gold Mining Funds

As the Indian athletes bring pride for India in the form of Gold in the Common Wealth Games 2010, providing pleasure to India in the tally table standing at second spot after Australia. The Indian athletes are simultaneously playing the role of Gold miners when the price of Gold is at record high of  19,900. Has the high price of gold motivated the Indian athletes to bring more gold? Certainly not, it is their effort in making India proud which has resulted in India ending at the second spot. However, the high gold price certainly brings higher allocation of gold into your investment portfolio.

 

Not to forget the miners or the athletes as we call them in this Common Wealth Games are not the same as those who begged gold for India in the Beijing Olympics 2008. The miners may not be consistent but the pride of gold remains the same. So what will you bet on the miners or the bars.

 

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 demand for this yellow metal. But along with the demand, there are host of factors like weak USD, economic turmoil etc which directly or indirectly affect the price of gold.

 

Currently you can hold gold as your investment in various forms like physical gold, gold ETFs or you can also benefit from gold price movements by investing in gold mining funds.

 

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 such as

 

• High holding cost,
• No quality assurance
• High premium charges
• Discounted resale value
• Wealth tax

 

Gold ETFs

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

 

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

 

• Convenient and efficient Storage cost
• Quality assurance
• Fair pricing (at prevailing market rates)
• Low maintenance charges
• Easy liquidity
• Tax efficient

 

World Gold Mining Funds

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.

 

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!

 

These funds are also 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 for only for those investors’ who have a high risk appetite.

 

Now one may ask, where should I invest - Gold ETFs or World Gold Mining Funds

Before answering the above query, let’s do some check on the various GETFs and World Gold Mining Funds available in the market and how does one know which is the best.

 

How GETFs have fared

 

Performance as on October 8, 2010, Portfolio details as on August 31, 2010.
(Source: ACE MF, PersonalFN Research)

 

You need to consider the following two factors while selecting a GETF.

 

• Percentage of holding in physical gold: Ideally, one must select a GETF that holds a significant portion of its portfolio in gold over ones that take cash calls; as this can result in high tracking error.
• Expense Ratio: One must also look at the expense ratio while selecting GETF. This is because a GETF with a lower expense ratio would translate into higher returns.

 

How World Gold Mining Funds have fared

 

Performance as on October 8, 2010. Given the daily performance of the fund’s Benchmark, i.e. FTSE Gold
Mines, is not available in public domain, we have compared the funds with International Gold Price
(Source: ACE MF, PersonalFN Research)

 

Before arriving at any conclusion after seeing the past performance of GETFs and World Gold Mining Funds, let’s do a small testing of how the funds in both categories have performed across market cycles (i.e. bearish and bullish phases in the equity markets)

 

How Gold ETFs and World Gold Mining Funds fared during bear and bull phases of equity markets

 

(Source: ACE MF, PersonalFN Research)

 

As seen in the table above, though world gold mining funds have out performed the gold and GETFs during bullish equity market phases, they have shown huge downside risk and have given negative returns in bearish equity market phases, while gold and GETFs showed a dream rally during the same crisis period.

 

It is prudent to understand that gold mining funds have high correlation to equity markets and they are pulled more by sentiments in the equity markets rather then gold price movement.

 

Our View:

We believe that investing in Gold ETFs is the smart way for investing in gold, for the advantages offered by it. 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.

 

Similar to athletes who won Gold for India in Beijing Olympics 2008 and have failed to beg gold in Delhi Common Wealth Games 2010, whom will you bet on for your pride? The inconsistent athletes (who may or may not be consistent achievers of gold) or the Gold medals (who maintain its value and pride). Well wherever the final tally stands (India finished at the second spot) in the Common Wealth Games, the pleasure and pride you get from your investment portfolio will be the consistency provided by pure gold holdings.

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