Ways to invest in Gold - Which is best option?

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In recent years gold has delivered exceptional returns. In a span of about 6 years — from 2006 to 2011 — gold has given an average return of an "incredible" 29% per annum. Therefore, it is but natural to be attracted towards gold. But let's not forget history. In 1980, gold prices jumped from 300 $/oz to 600 $/oz due to Gulf crisis. But soon thereafter fell to about 450 $/oz in 1981 and then NEVER crossed the $450 mark until 2006. In other words, gold gave ZERO returns over a period of nearly 25 years. The question, therefore, arises — are we going to witness something similar once this worldwide financial crisis is over? Is this a bubble that will burst? The answer, unfortunately, will be known in the future only.

Therefore, caution is advised, if you intend to invest in gold — especially now when it is trading at historic levels of 1600-1800 $/oz. However, from the asset allocation point of view, some portion of one's portfolio should be in gold. Accordingly, let us explore the different avenues available today to invest in gold.

a) Physical gold from jewellers/banks
Buying physical gold from jewellers has been the traditional way since centuries. And within physical gold, jewellery has been the most common form of purchase. The balance, in relatively small quantities, has been the gold coins and bars.

Recently, banks too have started selling gold coins/bars.

b)  Gold ETFs
Gold ETFs are mutual fund schemes that invest only in gold. Thus it is as good as holding gold; except that it is held electronically. Generally 1 unit of Gold ETF is roughly equivalent to 1 gram of gold and hence its price is also roughly equal to price of 1 gram of gold. You can buy a minimum of 1 unit of Gold ETF.

Recently, a fund-of-fund (FoF) type of scheme has been launched that invests in Gold ETFs. There is no difference per se, except that these funds do not require a demat account and also enable an investor to do systematic investment planning (SIP), which is not possible with ETFs.

c) Equity-based Gold Funds
These are mutual fund schemes that — instead of investing directly in gold — buy the equities of companies engaged in mining, extraction, processing and marketing of gold.

d) e-Gold
Launched recently by the National Spot Exchange, e-gold is also an electronic form of holding gold — except that herein you are directly the owner of gold whereas in Gold ETF the Asset Management Company is holding the gold (of course, on your behalf).

Unlike Gold ETF, e-Gold also offers the facility of physical delivery. However, given the additional costs involved viz. delivery charges, VAT and octroi, it may be better not to opt for physical delivery.

e) Gold Futures
This is just a short term product useful mainly for 'trading' in gold and not 'investing' in gold. Hence, it is kept out of the purview of this article.

Which option to choose

Given this wide variety of options, it is but natural to ask — which amongst these is the best alternative to buy gold?

If you intend to buy gold as jewellery for personal use, then of course, there is no option but to go to a jeweller. However, it may be noted that heavy making charges involved in jewellery will eat into the returns, if you use it as an investment.

And if bars and coins are desired, jewellers would comparatively be a better option as (a) their charges are generally lower than banks and (b) as on date banks can only sell gold — they cannot buy it back.

But if gold is being bought for investment purposes, holding it electronically has many advantages over physical holding.

• Low cost : To buy Gold ETF or e-Gold, you have to pay only the brokerage charges, which are usually around 0.5%. Vis-à-vis this, you may have to shell out anything between 10 to 20% as premium and/or making charges if you buy physical gold.

Of course, for ETFs you will have to incur the fund management charges (about 0.5-1%) every year, whereas e-gold and gold kept at home with no insurance could mean zero holding cost.

• Transparent pricing: For ETFs and e-Gold, the rates are linked to the international prices. But price of physical gold invariably varies even across various jewellers and banks within the same city. Thus, there are chances of paying more than the international price if you are buying gold from your local jeweller or banker. Moreover, even at the time of selling, you may have to take a large cut, especially if you sell to a different jeweller. 

• Purity: Gold ETF and e-Gold are of the highest purity and duly certified. But for jewellery, you have to trust your jeweller.

• Convenience: To buy Gold ETF or e-Gold, just a phone call to your broker or the click of the mouse is sufficient. You don't have to personally visit the jeweller/bank.

• Security: No one can steal your Gold ETF/e-Gold units. Physical gold, however, carries high risk of theft.

• Capital Gains Tax: In case of physical gold, the long-term capital gains tax becomes applicable only when the holding period exceeds 3 years. This limit is just 1 year in case of Gold ETFs. However, e-Gold is treated as a long term asset only after 3 years.

• Wealth Tax: Physical gold attracts Wealth Tax but Gold ETF is exempt. However, E-Gold attracts Wealth Tax.

So there is a trade-off between Gold ETF and e-Gold. Though e-Gold works out cheaper than Gold ETF as there are no fund management charges (and, depending on your broker, possibly lower brokerage charges also), it is taxable under Wealth Tax and it becomes Long Term Capital Asset after 3 years.

Accordingly, whether Gold ETF is good for you or e-Gold, will be determined by your investment amount, time-frame and applicability of Wealth Tax. 

As regards the other options:

 Fund-of-Fund schemes in Gold ETFs are slightly expensive as, apart from the annual fund management charges of the ETFs, you also have to bear the annual fund management charges of the FoF scheme. Therefore, if feasible, it is better to invest directly into Gold ETF rather than take the Fund-of-Fund route.

 Equity-based gold funds are riskier than gold ETFs/e-gold as there is an added element of equity risk in such funds. Moreover, there are no listed companies in India associated with gold. Hence, these funds have to invest in the international market. Therefore, these funds are essentially global funds; susceptible to currency-risk apart from equity-risk and gold-price risk. Given the substantially higher risk element, such funds ideally suit investors with high risk appetite. For the vast majority, however, buying Gold ETFs/e-Gold would be a more prudent option.

Concluding, therefore, Gold ETF and e-Gold would be the most preferred options amongst the various alternatives.

 

 

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