Asset Classes

Commodities – Gold

I. Gold

Gold is the most fascinating commodity to invest. The fact that gold plays a vital role in every Indian family irrespective of their religion, caste and creed cannot be denied. Gold remains the most sought after metal worldwide and more so in India. Traditionally, we all invest in gold in the form of jewelry or coin. But off late we have other forms or investment vehicles to invest in gold. As against the physical gold, investors in modern world has the option to hold gold in demat form that is called digital gold in general.

II. Gold investment vehicles

The various gold investment options are:

  • Physical Gold
  • Gold ETF
  • Gold Mutual Funds
  • Sovereign Gold Bonds

Physical Gold

Investment in physical gold does not need any explanation as we all are used to that traditional method of investing in gold. But, let us review the disadvantages of investing in physical gold in today's world. Apart from the safety issues of holding gold in household lockers, the value of ornamental gold diminishes once it is bought. Further, in addition to the high acquiring cost such as making charges and wastage, the purity of the gold is also questionable. However, when it comes to liquidity, physical gold remains the highly liquid asset at times of financial distress.

Gold ETF

Gold Exchange Traded Fund (ETF) is introduced to Indian investors in the year 2007 by Benchmark Asset Management Company. Exchange Traded Fund (ETF) is a pooled fund that invests in various asset class. Gold ETF invests in gold bullion of 99.5 per cent purity. It tracks the gold prices closely. It offers investment opportunity to small investors to invest in even 1 gram of gold. As the name suggests, exchange traded funds are listed and traded on stock exchanges. Investors who wish to invest in gold ETF can invest just like they invest in shares. Investing in gold ETF is easy, safe and cost effective as it does not attract securities transaction tax or wealth tax. Investors need to pay only the brokerage. However, gold ETFs held for more than three years attracts long term capital gains tax @ 20% with indexation benefit.

Investors who wish to invest in gold ETF should open a trading account with a stock broker and a demat account with depository participant. As gold ETF is a digital gold, investors are required to open a demat account to hold gold investment in digital form.

Gold Mutual Funds

Gold mutual funds are pooled funds that invests in gold ETF. Since it is a mutual fund, investors can invest as low as Rs.1000/-. Further, systematic investment plan (SIP) is also available to invest in gold mutual funds. There is no necessity of a demat account as the units of gold mutual funds can also be purchased from the respective fund house. Since it is a mutual fund, investors will have to incur the fund manager cost that is deducted in the NAV of the scheme. On tax front, if it is held for more than three years, it attracts long term capital gains tax @ 20% with indexation benefit and short term capital gains at the slab rate of the investor.

Sovereign Gold Bonds

Sovereign gold bonds are Government gold bonds issued on a periodic basis, usually once in 2-3 months. It was initiated in the year 2015 and it is issued by RBI on behalf of government. The subscription will be open generally for a week. The tenure of sovereign gold bonds are eight years with lock in period of 5 years. Redemption price on maturity will be equal to the prevailing price of gold.

Sovereign gold bonds are listed and traded on stock exchanges. Hence, investors who wish to invest in sovereign gold bonds (SGB) can do so at the time of its launch or they can invest at market price once it is listed in the stock exchange. It also offers exit route to investors, but, however the capital gains arising out of the investment is taxable as short term capital gains.

An interest @ 2.5% per annum is paid on gold bonds to the investors on half yearly rest. The interest so earned on gold bonds are taxable as per Income Tax Act. However, capital gains on redemption amount on maturity is not subject to tax. Another advantage with SGB investment is that it can be used as collateral for loans.

Comparison of pros and cons of gold investment vehicles

III. Regulators

Trade and investment in Gold is regulated by various organization according to the role or definition of gold. Generally as a commodity, gold is regulated by Ministry of Consumer Affairs. Whereas, the financial forms of gold, investment vehicles such as Gold ETF, Gold Mutual Funds and Gold Futures are governed and regulated by Securities and Exchange Board of India Ltd (SEBI). Import and export of gold is regulated by Reserve Bank of India (RBI) and Ministry of Commerce.

IV. Why to invest in Gold?

Though there are developments in the new modern innovative investment products, gold has not lost its glitter and value to anything else. Gold forms an important part in one's financial plan. People invest in gold for many reasons, mainly due to its attribute as a highly liquid asset.

Liquidity

Gold is the highly liquid asset which can be monetized faster and in easy way. While physical gold can be liquidated within few minutes, gold ETF can be sold anytime during market hours just like you sell a stock. And just like in case of selling a share, investor will receive the sale proceeds in his trading account with a stock broker on T+2 basis. That is “T” being the traded date and plus 2 is the next two working days. Likewise gold mutual funds can be redeemed anytime with mutual fund house or through mutual fund app provided by your stock broker. Tradeplus has a mobile app “Infini MF APP” for both android and ios users wherein the investors can invest or redeem and track their investment in all mutual funds.

In the case of Sovereign gold bonds, though it has a lock-in period of 5 years, it can be sold in market just like a stock through your share trading account with your broker.

Hedge against inflation

Over the years, gold is being used as a hedge against inflation. Since, purchasing power of money decreases in an inflated economy, the value or price of gold increases. This increase in price of gold will act as an hedge against inflation. To understand this, let us assume that you had invested all your money in a bank fixed deposit which earns an interest of 6.5% per annum. When the inflation rate is 8% do you think you will be able to buy products and services with the money you have in bank which has grown by just 6.5% while inflation is at 8%? It will not be enough. Isn't it? The only investment asset which grows in tandem with inflation is gold. So, investing in gold is considered to be a good hedge against inflation over a period of time.

Provides Diversification

Diversification in investment portfolio is vital to achieve our financial goals. Having a well diversified portfolio means investing in various asset class which has negative or inverse co-relation. Gold is one such asset class which has negative co-relation to other asset class such as equities. Gold prices will go up when there is a fall in the stock market and value of currency. The returns from stock market will fall when economy slides into recession and during this period gold prices tend to appreciate. Hence, holding gold in the investment portfolio proves to be a good financial plan to overcome risk and volatility in other asset classes.

Collateral

While stocks and other asset class are accepted as collateral for loans, it is the gold that is widely used as collateral because of the easy and simple procedure. Moreover, it is the highly liquid asset to liquidate at times of default on the part of the borrower. In India, gold ETF and sovereign gold bonds are accepted as collateral apart from physical gold. The collateral value assigned to physical gold depends upon the purity of the gold. Whereas, since purity is guaranteed in gold ETF and sovereign gold bonds, it would fetch higher value for the borrower.

Safe haven

Gold is generally considered as a safe haven during times of turmoil. When there is geopolitical tension globally gold prices goes up. Though many examples could be cited, recently in 2019, gold prices bounced from its lows due to rise in geopolitical tension between US and Iran. The news of US plan to end waiver of sanctions on Iranian oil made investors to pull out from stock markets and invest in gold. Generally, when the world confronts with geopolitical tensions, stock market falls and gold tends to move up and hence it is considered to be a safe haven.

V. Factors that impacts gold prices

As with any other asset class, there are numerous factors that impacts gold prices.

US Dollar

Since international gold is dollar denominated, any change in the value of US dollar has huge impact on the prices of gold. When US dollar weakens the value of all other currencies and commodities worldwide increases. This prompts investors to pull out of dollar investment and move to safe haven gold pushing the gold prices up. When US dollar strengthens, investors flock to invest in US currency and opt out of gold investment and this pulls down the gold prices. US dollar strengthens when the US economy is strong and investors are inclined to invest in stock markets and other assets rather than gold. This pulls down the gold prices.

Inflation

When an economy flourishes, inflation will be high with increased money supply, eventually decreasing the purchasing power of money. Due to this, the cost of all commodities including gold goes up. So, in an inflationary scenario, the gold price tends to go up and in an deflationary situation, gold prices will fall. The change in gold price will generally be equal to the change in inflation. Suppose inflation increases by 1%, gold prices also increases by 1%.

Interest rates

When interest rates in an economy are rising, gold prices fall. This is because investors move to interest bearing securities from commodities. And when interest rate falls, gold prices move up with investors pulling out of interest bearing securities and buying gold.

Economic and Political uncertainty

Global economic and political uncertainty has an impact on the price of gold. During the global crisis like in 2008 which is of Lehman collapse, stock markets worldwide crashed and gold prices nearly doubled since then. The latest geopolitical tension between US and Iran over sanctions are leading the gold prices on the ladder.

Demand and Supply

As true with any other commodity, the demand supply economics has an impact on the gold prices. The increase in demand for the metal without corresponding increase in supply pushes the prices of gold. Apart from the consumption demand, the investment demand for gold is also increasing. The increase in investment demand for gold can be known from the activity of largest gold ETF “SPDR Gold Shares ETF”.

Key points to remember

  • Apart from physical gold investment there are other investment vehicles for gold investment
  • Various investment vehicles available for gold are Gold ETF, Gold Mutual Funds and Sovereign Gold Bonds.
  • Gold investment vehicles such as Gold ETF, Gold Mutual Funds and Gold Futures are governed and regulated by Securities and Exchange Board of India Ltd (SEBI)
  • Gold prices movement is impacted by US dollar movement, economic and political uncertainty and demand and supply.
  • Gold should form a part of total portfolio as a diversification
  • Gold is a good investment asset because of its attribute of being a safe haven and also because of its liquidity and it can be used as a hedge and collateral.

Roundup

Over the years, from a family oriented treasure gold has transformed to mass consumption commodity. And more importantly it is a compelling asset to find place in investment portfolio as it provides effective diversification and safety during times of economic and political uncertainty. In modern investment world investors have various investment vehicles such as gold ETF, gold mutual funds and sovereign gold bonds from which they can choose the one that suits their objectives.

 

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