Invest in Gold the smart way    Oct 11, 2010

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.

Data as on September 6, 2010
(Source: World Gold Council, PersonalFN Research)

Historically gold prices are determined by a combination of political and economical 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.

Note: Gold Prices taken of MCX Spot Mkt.
Data as on October 8, 2010
Base: 10,000
(Source: ACE MF, PersonalFN Research)

The chart above also indicates that during the U.S. Subprime mortgage crisis of 2008, Gold became bold, whereas equity as asset class lost steam. Hence 10,000 invested in Gold on November 13, 2007 (almost couple of months before the U.S. Subprime mortgage crisis) would have been worth 18,740 on October 8, 2010; whereas similar investments in BSE Sensex and the Dow would have yielded 10,638 and 8,639 respectively.

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.

Hence, hereunder at PersonalFN, we have tried to evaluate the various options for gold investing, in order for you to be prudent while investing in gold.

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.

Now one may ask, from the host various GETFs available in the market, how does one know which is the best. Well, it’s simple. You need to consider the following two factors while selecting a GETF.

How GETFs have fared

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

  • 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 i.e. invests in current assets; the impact of this on performance can also be disclosed through the tracking error of the GETF.

  • 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.

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.

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)

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.

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

(Source: ACE MF, PersonalFN Research)

The table above shows how gold safeguards investors’ wealth during the downturn of the equity markets, and similarly under performs when equity markets are in the bullish phase.

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.

Add Comments


Feb 18, 2013

The information is really helpful. I would also looking at some suggestions based on the CAGR and  expenses ratio comparison for company to company.

At the same time I would also wondering that the figures of CAGR returns in the bearish and bullish trends are correct as they might have interchanged by looking at their figures.
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Jun 24, 2012

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Sep 21, 2012

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