Diversification series 1 - Gold

The safe-haven appeal of the gold as an asset class has once again got a boost as the spread of the new coronavirus variant in South Africa made investors across the globe anxious. Besides the preferred choice during uncertain times, gold traditionally have always been a symbol of wealth and prosperity.

Diversification series 1 - Gold

The safe-haven appeal of the gold as an asset class has once again got a boost as the spread of the new coronavirus variant in South Africa made investors across the globe anxious. Besides the preferred choice during uncertain times, gold traditionally have always been a symbol of wealth and prosperity. Intermittently, investors interest in the yellow metal has been lukewarm due to higher rates and likelihood of the US Federal Reserve’s increasing the interest rates. But given the low correlation of the gold against other asset classes like equity and hedge against the inflation which also rising off late, gold prices might the gain the momentum going forward and hence its inclusion in the portfolio is essential. In this article, we look at what are different investment options which enable investors to take exposure to this valuable commodity.

Trend of the gold prices in India

Source: BankBazaar.com

Notes: The chart represents average annual price of the 24 karat of gold per 10 grams

Gold prices have seen sharp upswings ever since the year 2001 and got a massive boost post sub-prime crisis and post pandemic times in 2020. The average annual price jumped from Rs 12,500 in 2008 to Rs 48,651 in 2020.

Gold investment avenues in India

Investors can choose to invest in gold in two forms – physical or digital. 

Physical gold

The physical gold option comprises of the buying of the gold bars, coins or jewellery. Investors should buy the hallmarked jewelry which is mandatory in India and ensures the purity of the metal. Buying of the physical gold do have limitations in terms of risk of theft, storage cost, payment of the making charges and Goods and Services tax (GST) at the time of the purchase. Further, the prices are subjected to fluctuations. Buying of the gold in form of jewellery or bars has a sentimental aspect and purchased on auspicious occasions and festivals like Dhanteras, Akshaya Tritiya and wedding. While one can pledge the physical gold and take a gold loan. Proper due diligence is essential before investing in the physical gold.   

Sovereign Gold Bonds (SGBs)

Another alternative to physical gold are the sovereign gold bonds issued by the Reserve Bank of India (RBI) on behalf of Government of India eliminating the risk of theft and storage costs associated with physical gold. SGBs are denominated in grams of gold. The minimum investment is 1 gram. The maximum gold you can buy through gold bonds is 4 kgs for individuals and Hindu Undivided Family (HUF) and 20 kg for trusts and similar entities notified by the government.

Tenor of the bond is for a period of 8 years with exit option after 5th year to be exercised on the interest payment date. The bonds are tradeable on the exchange and can be transferred to any other eligible investor. Besides the capital appreciation (appreciation in gold price between the time of purchase and redemption), the investor will be paid a fixed interest rate of 2.5% semi-annually. Unlike in case of physical gold, there is no making charges and goods and services tax (GST) levied on SGBs. While the interest on the bonds will be taxable, the capital gains arising on redemption of SGB to an individual has been exempted. The indexation benefits will be provided to long terms capital gains arising to any person on transfer of bond. Lastly, bonds are highly liquid and used as collateral for the loans.  Investors can apply online for these bonds through website of the banks, bonds are held in the demat form and upon redemption the amount gets credited to investors’ account.

Gold exchange traded funds (ETFs)

ETFs are the passive mutual fund schemes that aims to track the domestic physical gold price. One Gold ETF unit is equal to 1 gram of gold and is backed by physical gold of very high of 99.5% purity. These ETFs are traded on the exchange making it easier to buy and sell the units at market prices. Trading of gold ETFs takes place through a demat account and a broker making it a hassle-free way of electronically investing in gold.   Gold ETFs can be one of the ideal investment options for investors due to following reasons:

Gold mutual funds are actively managed fund of funds (FoFs) that invest the corpus in either their own gold ETFs or a foreign gold fund which is the mother fund. Investment in the gold mutual funds give the benefits of professional management and capture the upside potential of the asset class. Units of the gold mutual fund scheme can be purchased from the mutual fund house and involves expenditure in form of loads and expense ratio. Investors can do systematic investing and given negative correlation of the gold with equities a smaller portion invested in these funds can cushion the portfolio against the market volatility. The units of these funds can be redeemed from the fund house. Due diligence of the fund performance, fund manager track record, cost involved and portfolio attributes is vital before investing.

Digital gold is a new age investment product offered by refineries such as MMTC PAMP, Augmont and SafeGold through different digital payment service providers like Paytm, Gpay, PhonePe, Aditya Birla Capital and jewellers. Digital gold allows investors to invest in 24 Karat gold of 99.5/ 99.99 purity. Once the investor purchases the gold, it is stored in the secured certified vaults of the seller and get the digital invoice of the same. Gold is stored for 10 years wherein the storage of the gold is free of cost for the first 5 years and later on fee is charged for the next 5 years. Investors can sell the gold and get the money back to their bank accounts. They can also take the delivery of the gold by paying certain charges.

While the demand for the digital gold has seen upsurge in the backdrop of the pandemic and given the simplicity, transparent pricing aspect. However, one of the biggest concerns with the digital gold is that it is not regulated by SEBI or RBI in India. SEBI has barred brokers from offering digital gold and also banned registered investment advisors from making recommendation about this product. Some of the other worry factors associated with this product is no assurance that the physical gold purchase is taking place, the product is non-transferable, no nomination facility available and if the refiner defaults or the distributor terminates the services than the investor wouldn’t be able to access the units available in their account or recover the gold.  Also limited number of providers increases concentration risk.  Hence, investors need to carefully evaluate this product before investing or stick to other above-mentioned alternatives like bonds and ETFs.

Comparative analysis of the all the gold options in India

Source: Financial website     

Table is just for representation purpose, due diligence and consultation with the financial experts is must before investing

Summing up

As we saw the key features and risk factors associated with each of the gold avenues in India it is quite evident that sovereign gold bonds can be good option for investors with low-risk appetite and having long term horizon.  Investment in gold ETFs and gold mutual funds can be beneficial in many ways. Consider investing in physical gold only in a very small portion only during wedding or in case of the mandatory buying in the festive season. Don’t venture into digital gold as it lacks the regulatory foresight in India and highly risk. Gold prices can be highly volatile in the short run but have the ability to glitter in the long run and especially during uncertain times and market volatility. As the pandemic risk still persist investor should consider investing smaller portion in gold only in line with their risk-taking ability and taking a help from the financial advisor if needed.