Gold Exchange Traded Funds: Understanding a Different Form of Gold

10 Dec 2020  Read 892 Views

"Gold is no longer an investment. Gold is no longer a portfolio item. Gold is certainly not a trading vehicle. Gold is your lifeline and I mean that literally."

~ Jim Sinclair

Gold as an investment avenue is a heaven on earth as it has a plethora of benefits but let’s not forget that this shiny fella is worth a king’s ransom making it difficult for a majority to acquire it.

However, God bless the community of investors who have formulated an inexpensive route for everyone to get exposure to the shiny metal, Gold Exchange Traded Funds (Gold ETF). Well, this less-known method of approaching gold markets might have sparked a series of questions in your mind like what is it, is there any risk involved, how is it different from other alternatives and how can a neophyte start their venture.

Therefore, here we are to answer some of the most generic aforementioned queries which will help you in understanding the importance of gold and Gold ETF as an investment and investment instrument, respectively. Buzz in, fervent learners!

Gold ETF

Gold Exchange Traded Fund (Gold ETF) is an open-ended commodity based investment instrument which predominantly invests in gold bullions and derives its value from the price of physical gold prevalent in the market.

Each unit of a Gold ETF represents 1 gram of physical gold with a purity value of 99.5%.  As the name suggests, this investment tool is exchange-traded for which it is listed on the cash segment of National Stock Exchange (NSE) & Bombay Stock Exchange (BSE). Thus, investing in Gold ETF means that an investor is acquiring gold in an electronic format and will be receiving a cash equivalent on redemptions. 

Features & Benefits of Gold ETF

1. Storage

Unlike physical gold, this commodity based instrument is stored in a dematerialized form which indicates the ownership details and the amount of gold held in electronic format protecting an investor from getting robbed.

2. Liquidity

Gold ETFs offer a high liquidity as they are exchange traded because of which an investor does not need to go looking for a buyer who may not accept it (looking at the condition of physical gold or because of the price that it is trading on in the market.) 

3. Affordability

Gold ETFs are available in various small denominations which allows an investor to start investing from buying as low as 1 gram of gold. 

4. No Entry / Exit load

Entry and Exit load is a certain percentage of money which gets deducted from the investable and invested sum of money. But this isn’t the case with Gold ETFs  as the Asset Management Company (AMC) does not charge any entry or exit load on investment into Gold ETFs and rather an investor is required to pay a minimalistic brokerage charge of 0.5% to 1%. 

5. Taxation

Gold ETFs are subject to taxation based on short term and long term capital gains

  • STCG - If Gold ETFs are held for less than 36 months then the returns are taxed according to the income tax slab that an investor falls under. 

  • LTCG - If Gold ETFs are held for more than 36 months then an investor is liable to pay a tax equal to 20%(plus any cess) with the benefits of indexation. 

6. Cost-effective

Acquiring Gold ETF is a cost effective way of getting exposure to the market of gold because of the fact that unlike physical gold, this investment instrument is not subject to mark up charges which may sometime constitute upto 15% of the total purchase price. 

7. Transparency & Uniformity

The data shown below displays the price of 10g physical gold across different cities in India as of 13/07/2021:

(Source: goodreturns.in)

It’s quite evident that a person living in Jaipur will make more money by selling 24 carat gold than the person living in Mumbai. This shows how trading in physical gold gives unfair advantage. But this is not the case when it comes to Gold ETFs as the underlying gold is priced in accordance with rates in the international market.

8. Hedge against inflation

Gold as an asset class has mostly maintained a negative correlation with inflation which if said in simpler terms means that for a majority of time gold has delivered returns over the percentage by which price of goods and services have increased.

9. Saviour

Investment in gold has always been beneficial especially when it comes to protecting the value of a portfolio which is falling due to fall in equity markets. But why is that so? It is simply because of the negative correlation between the gold and equity markets. 

Gold ---- | Nifty50 Index -----

(Source: Tradingview)

10. Collateral benefits

One of the serious advantages of investing in Gold ETF is that it can be used as a collateral while soliciting a secured loan from any financial institution.It help a loan seeker negotiate the terms on applicable interest rates and it can also aid a borrower in saving by making the process of availing a loan a lot simpler than it would have been in general situations. 

Gold ETF vs Physical Gold 

Parameters 

Physical Gold

Gold ETF

Meaning

A consumable form of gold which may or may not suffice the purity level of 99.5%.

A Gold Exchange Traded Fund (Gold ETF) is an open-ended commodity based passive investment instrument which is backed by gold of 99.5%purity level.

Exchange Traded 

No.

Yes.

Price

Varies from state to state.

Uniform price throughout the market.

DEMAT Account requirement

No.

Yes. 

Denomination

Minimum investable amount is quite high as they are available in standard denominations of 10 grams. 

Minimum investable amount is low as they are available in small denominations starting from 1 grams.

Cost of acquiring 

Acquiring physical gold is expensive as the mark up cost of up to 15% gets added to it.

It is a cost effective way of getting exposed as there are no entry/ exit/ markup charges involved.

Wealth Tax

Yes. (If the total amount of acquired gold reaches Rs. 30 Lakhs)

No.

Taxation 

STCG - According to the income tax slab (if held for less than 36 months) 

 

LTCG - 20% with indexation benefit if held for more than 36 months.

STCG - According to the income tax slab (if held for less than 36 months) 

 

LTCG - 20% with indexation benefit if held for more than 36 months.

 

10% without indexation benefit.

Liquidity 

Moderate.

High. 

 

Risk Factor in Gold ETFs

1. Fluctuating Net Asset Value (NAV), 

2. Fluctuating  price of the underlying commodity of gold 

3. Changes in the regulations imposed by the SEBI Mutual Funds Regulations.

Summing up...

Irrespective of the way you choose for getting exposure to the market of yellow metal just make sure that you don’t park a big chunk of your investable corpus or a good portion of your portfolio in it, the reason being the seasonal behaviour of gold.

Moreover, if you scrutinize the chart where returns from gold and Nifty50 have been compared, there is a notable negative correlation amongst them which translates into a fact that if there is a bull run in the equity market, the claws of gold will bring down the overall portfolio return.

Well, you will be highly mistaken if your perspective towards gold has turned negative in view of the fact that gold isn’t a depressing asset class, it just requires a tactical asset allocation strategy where an investor has to invest according to the sentiments prevalent in the sphere of specific asset class.

Invest wisely!

About the Author: Prabudh Mishra | 4 Post(s)

Prabudh Mishra is a finance and behavioral economics enthusiast. He has a sense of purpose to eliminate irrationality in human behavior while they make the most crucial financial decisions in their life.

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