Invest in Gold: The 'ETF' - way   Feb 11, 2009

ETF Gold investment

Until January 2008, the stock markets witnessed an almost secular bull run for nearly five years. That was the time when equity-linked investment avenues were favorites with investors. It took a sharp fall in equity markets for investors to look beyond equities and consider other investment avenues. Since then, gold is an asset class that has attracted a lot of attention. The reasons for the same are not difficult to guess.

From its peak in January 8, 2008, the BSE Sensex is down by nearly 54% till date. On the other hand, gold has appreciated by almost 25% over the same period. Expectedly, gold has caught the investor’s fancy. At PersonalFN, we have received a number of queries from investors wanting to know how they can invest in gold. In this article, we discuss the Gold Exchange Traded Fund (Gold ETF) route of investing in gold.

Options for investing in gold

Not too long ago, buying physical gold was the only option for investing in gold. However, the launch of Gold ETFs threw open another option for investors. Gold ETFs are open-ended funds which track prices of gold. They are listed and traded on a stock exchange; hence, they can be bought and sold like stocks on a real-time basis. These funds are passively managed and they mirror domestic gold prices. By enabling investors to invest in gold without holding it in physical form, Gold ETFs offer a rather unique investment opportunity to investors.

Advantages of Gold ETFs

Although the mode chosen for investing in gold would entirely depend on investors, Gold ETFs do offer some distinct advantages vis-à-vis investing in physical gold.

1. Convenience: Gold ETFs are a convenient means of investing in gold. Since there is no delivery involved, investors do not have to worry about the storage and security aspects that are typically associated with investing in physical gold.

2. Quality: As per SEBI regulations, the purity of underlying gold in Gold ETFs should be 0.995 fineness and above. This spares investors the trouble of finding a reliable source to buy gold.

3. No premium: Jewellers and banks generally sell gold at a premium. The premium can be in the range of 5%-10% (inclusive of making charges) in case of jewellers and upto 15% in case of banks. Since Gold ETFs are traded on the stock exchange, they can be bought at the prevailing market rate without paying any premium.

4. Low cost: To store physical gold, one would typically need a locker. This expense is over and above the premium paid at the time of buying physical gold. As for Gold ETFs, a pre-requisite is to have demat and trading accounts with a broker. To maintain these accounts, investors are required to pay annual charges, which vary from broker to broker. Investors also have to pay the brokerage on each trade. Finally, there are annual recurring charges which are charged to the fund.

Considering the premium and other charges borne while buying physical gold, investing via Gold ETFs can turn out to be a more cost-effective option.

5. Transparent pricing: The pricing of physical gold varies depending on the vendor. Conversely, Gold ETFs have a transparent pricing mechanism. International gold prices are converted to Indian landed price using the applicable exchange rate. Various duties and taxes are also added to arrive at the landed price of gold.

6. Tax efficiency: In Gold ETFs, long-term capital gains tax is applicable after twelve months from the date of purchase vis-à-vis three years in the case of physical gold. Also, unlike physical gold, investments in Gold ETFs are not subject to Wealth Tax.

7. Resale value: Gold ETFs 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.

Tax implications
Tax implications on Gold ETFs are same as those on debt mutual funds. A unit of a Gold ETF that is held for less than twelve months is treated as a short-term capital asset. Gains on the same are taxed at the investor’s marginal rate of tax. Units held for more than twelve months are treated as long-term capital assets. Long-term capital gains are taxed at 20% (after allowing for indexation benefit) or 10% (without indexation benefit), whichever is less.

Criteria for selecting a Gold ETF

Following are some of the factors that investors must consider before investing in a Gold ETF.

a. Percentage of holdings in physical gold

Ideally, investors must select a Gold ETF that holds a significant portion of its portfolio in gold over ones that take cash calls i.e. invests in current assets.

b. Expense Ratio

Investors must choose a fund which has a lower expense ratio. Higher expenses translate into lower returns for investors.