Posted in Finance Articles, Total Reads: 2180
, Published on 31 July 2013
ETF – Exchange Traded Funds are funds that track an index or an underlying commodity or an asset. Price fluctuations for ETFs occur throughout the day and it is traded like a stock.
Gold is an asset class that is considered by investors for asset allocation. Gold ETFs are in existence for more than four years and they provide an investor some exposure to gold as they are the simplest means to trade in gold.
Gold – An Investment Option
Gold is one of the safest havens for investment. Gold has given spectacular returns over the past decade. The gold prices have been ever increasing and haven’t seen much of fluctuation. During the last couple of years, dollar prices have been falling and as a result dollar has weakened. The countries therefore prefer gold reserves over dollar reserves, especially China which has built a huge reservoir of gold. With increasing inclination towards the yellow metal and increased ways of investing, the proportion of people investing in gold had also been increasing.
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Gold acts as an effective hedge during uncertain times. Gold has outperformed equity, debt and gilt mutual funds on a 3- and 5-year basis. Gold has positive correlation with inflation hence effective as a good hedge. Also, gold is one asset class that does not have cyclic movements and provides healthy returns. They are tax efficient and extremely easy to buy and sell
An investor can invest in gold in numerous ways:
Physical Gold: Physical gold is the most popular and safest form of long term investment. This is mostly done in the form of gold jewellery, gold coins and bars.
Gold ETF: Gold ETFs are exchange traded funds. The price depends on the price of Gold in the market. Gold ETF is safe as there is no need of physical possession.
Gold Funds: Gold funds are fund of funds which invest in a set of Gold ETFs. This is equivalent to investing in Gold ETFs indirectly.
eGold: eGold is the electronic mode of investing in gold. It allows conversion to physical gold at any time. Investors can also buy gold units in demat form on the National Spot Exchange (NSEL) platform.
Gold ETFs are one of the most popular ways of investing in gold. It is a financial product that is listed on a stock exchange and represents ownership of underlying gold assets. It can allow investors to easily participate in the gold market.
Origin of Gold ETFs
The World’s first Gold ETF (exchange-traded fund) was launched in Australia in March 2003. In US, first Gold ETF was launched in 2004.
But the idea was originated in India way back in 2002 when Benchmark filed a proposal with SEBI in May 2002. However, it could not be launched at that time due to not getting the required regulatory approval. Finally, in Feb’2007 Benchmark launched India’s first gold ETF.
Trading with Gold ETFs
Cost of one unit of GETF = Cost of one gram of gold on the date of allotment. This is the standard adopted by most of the gold ETFs schemes.
Most mutual fund schemes impose a kind of tax called 'load' while buying or selling units. The former is called 'entry load' and the latter is called 'exit load'. Many schemes do not levy any entry load when these GETFs start trading on the NSE.
Gold ETFs (GETFs) are traded like the shares on the stock exchange. De mat account is required for the same. Also, it is required for the investor to register with one of the brokers listed with the NSE. The prices of GETFs can be monitored online like for the equity portfolio.
A brokerage fee varying from 0.4% to 0.6% (depending on broker) is charged for using the brokers’ platform for the transactions. DDT (Dividend Distribution Tax) is levied on the investors in case GETFs declare dividends for its investors. There is no Wealth Tax or Securities Transaction Tax (STT) levied on the same. There is no STT because GEFTs are sold as non-equity. STT is applicable only when shares are bought or sold. Also, since the gold is not possessed in physical form, wealth tax is not applicable.
The gains on GETFs also attract short term capital gains (STCG) tax if held for less than one year and long term capital gains (LTCG) tax if the period of holding is more than a year.
Gold ETFs are actively traded in on the exchange; hence it can be easily liquidated during market hours. Liquidity affects the price of the ETF. The quoted price of the ETF on the exchange varies from the net asset value (NAV) disclosed by the mutual fund. For instance, if there are more buyers, strong demand for the ETF can drive up the price, way higher than the NAV.
Selling ETFs is easy as there is a transparent quoted price for each unit. As ETFs are traded in the stock market, they can be converted into cash faster than physical gold. In jewellery, there may be deductions on account of wastage. But liquidity may vary across ETFs issued by different fund houses.
There is active trading for gold ETFs on the exchanges ensuring sufficient market for buying and selling. Trading volume differs for different gold ETFs; some bubble with activity while for others it may not be that active. Good liquidity is an important criterion to look for while choosing an ETF.
How has Gold ETF changed the world market?
The first gold-backed exchange-traded fund is now more than 10 years old. It is widely acknowledged that the launch of gold [exchange-traded products] has had a very significant impact on the gold market. On March 28, 2003, the first gold-backed ETF, developed by ETF Securities, was launched. It trades on the Australian stock exchange as the ETFS Physical Gold, with assets under management at about $602 million.
Since its launch, interest in gold has grown astronomically Mumbai-based Benchmark Mutual Fund which first started Gold ETF has the largest collection of more than five tonnes.
The first gold-backed ETF in the United States, the SPDR Gold Trust, launched on Nov. 18, 2004. GLD, the largest gold ETF on the market, is also one of the biggest funds in terms of value of the assets it manages.
Among the biggest reasons for the popularity of gold ETFs has been the accessibility and addition of liquidity in the market. Before the first gold ETF, investors could not invest in gold easily. They could buy coins or bars, but due to the costs of storage and acquisition, it was a market for specialists. The introduction of the ETF provided people with access to the gold market in equity form for the first time.
However, there are some negatives linked to gold ETFs. A gold-backed ETF is not an exact proxy for gold and has become a victim of its own success. The same liquidity and size of the market has made it a problem for the ETF sponsor to physically control that much gold without impacting the markets.
ETFs can disrupt the price and trading mechanism if the size of the gold ETF holdings continues to increase. Gold equities were traditionally the method by which investors leveraged the moves in the metal. Ironically, then, while the ETFs have helped the price of gold, they have hurt the companies that mine gold. Gold companies have had a hard time outperforming the gold price over the last few years and, as such, more investors are simply electing to buy the gold ETFs directly.
There is no sign that the drivers for gold, which include rising U.S. government debt, are about to abate and demand for gold will eventually overwhelm the short futures and ETF short speculators. That leaves a lot more room for interest in gold-backed ETFs — and gold — to grow.
Risks involved in Gold ETF
Some of the risks faced by the Gold ETF could be enumerated as below:
• Risk faced due to any fluctuations in the price of gold.
• Lack of protections associated with ownership of shares in an investment company registered under the Investment Company Act of 1940 or the protections afforded by the Commodity Exchange Act of 1936.
• Gold ETF being the direct competitor for the physical Gold suffers from the lack of support from the World Gold Council.
• Competition from other methods of investing in gold, which are considerably older and still finds many takers in the market where ETFs has not yet become popular.
ETF has definitely made a mark on the Indian Investment panorama and has introduced a new investment opportunity for the investor. For linear gold investments, gold ETFs offer clear advantages over other gold products. As the market matures, we are going to see a lot of action on the ETF horizon and newer products and instruments changing the entire scenario.