You get to use jewellery, but its purity, storage, making charges pose problems. Higher tax on profits from sale
High risk—you can make or break a fortune.Only 5% margin required as investment. Not for lay investors.
No purity or storage issue, high liquidity, lower tax on profits than metals and ease of investment
Invest in companies involved in gold mining and production. Same as ETFs in liquidity and tax
|Click here to see analysis of ETF and gold fund returns|
|The first step to investing in gold is to segregate consumption from investment|
—Gaurav Mashruwala, Financial planner
Gold moves in line with inflation and is a protector of money rather than a creator
—Karthik Jhaveri, Financial planner
Despite the sharp rise, gold is still undervalued. It may touch $1,400 by mid 2011
—Pritam Patnaik, Assistant vice-president (sales), Kotak Commodities
When gold prices rise, the profitability of gold firms rises more than proportionately
—Saurabh Sonthalia, CEO, AIG Investments
Gold is seen as an ideal way to diversify the risk in an investment portfolio, thanks to its strong negative correlation with stocks. At the same time, it has a positive correlation to oil, and with oil prices ruling above $114 a barrel, gold prices are steadily rising. The metal has delivered an astounding 24% returns compared to a negative 15% delivered by the equity markets since October 2007.
The good news for investors in gold goes beyond the arithmetic. In the past few months, the choices in the mode of investment in the metal have grown. There are now seven gold funds in India. Not only can you invest in paper gold through these funds but also in global companies involved in the mining and production of gold. You can also take leveraged positions and invest in gold futures by paying a small 5% margin.Metal or paper?
India has historically been among the largest consumers of gold. As a nation, we tend to buy physical forms of the metal—coins, bars and jewellery. “The first step to investing in gold is to segregate gold consumption from gold investment,” says Gaurav Mashruwala, certified financial Planner. You could buy gold in the form of jewellery for adornment or stack up physical gold for your daughter’s wedding, but if you wish to invest into gold for the long term then buying physical gold may not be an ideal option.
Physical gold typically comes with drawbacks like concerns on purity, cost of storage and security. The most authentic source of gold is buying through banks, which certify its authenticity but cost 5-10% more than your local jeweller. But do remember that while banks sell you gold, they don’t buy it back. Likewise buying gold in the form of jewellery would cost an additional 15-20%, depending on the jeweller; branded jewellery comes with mark-ups of over 25%.
If you want gold as an investment, you will most likely be better off with options such as gold funds. The country’s first gold exchange traded fund (ETF) was launched only last year and since then there are five funds in this category managing about Rs 500 crore. Since these funds invest their corpus into gold, they mirror the performance of spot gold and have returned about 27% in the last one year. Your holding in these funds is denoted in units, transferred to your demat account and listed on the stock exchange.
Thus, they can be bought or sold anytime during market hours with limit, stop and market orders and the option of buying units of as low as 1 gram (0.5 gram in case of Quantum ETF) . “Investing in gold through ETFs is a much more costefficient and convenient option,” says R Swaminathan, national head of mutual funds, IDBI Capital.
Investing in gold funds also enables rupee cost averaging by purchasing units over a period of time like an SIP, says Mashruwala. To buy an ETF from the exchange, you would pay a one-time brokerage charge of 0.4-0.5%, depending on your broker, which turns out cheaper than buying these funds during an NFO where you would end up paying an entry load of 1.5%. Also, since these funds are passively managed, the annual expense ratio is only 1%, much lower than other mutual funds.Fund of funds
There is a new class of funds that invest in global companies involved in the mining and production of gold. DSP Merrill Lynch World Gold Fund and the newly launched AIG World Gold Fund both want to profit from the gold rush. They invest in units of their international funds, which, in turn, invest in gold mining and production companies. Investing in these fund of funds, in fact, serves a dual purpose: you get the advantage of profiting from gold prices, and your portfolio gets some global diversification as well.
“Buying gold funds makes more sense since one is buying into a business and participating in profits as well as the price movement of gold,” says Karthik Jhaveri, certified financial planner. Since the cost of production is not increasing, any increase in gold price directly flows to the bottom line. “When gold prices rise, the profitability of gold companies tends to increase more than proportionately,” says Saurabh Sonthalia, CEO-AIG Investments. This rise could be anywhere between one and two times the price of gold. On the downside, a slump in gold prices will impact returns in a similar way.Gold Futures
Investing in gold through futures has also caught on in recent times, mainly due to the leverage it provides. You can take a long position in gold futures by paying only an initial margin of about 4% and your brokerage, which ranges from 0.05-0.20%. “Since you only pay the margin, the return on investment is much higher compared to buying physical gold where one has to pay 100% of capital,” says Hiren Sanghvi, head, BRICS Commodities.
While the profit potential is high, the loss could also be significant, he adds. Further, these contracts come in rigid contract sizes and a contract length of only three months. So, if you want to stay invested after the contract expiry, the contract needs to be rolled over to the next month, the average cost for which is 5.5-6% annually, says Pritam Patnaik, assistant vice-president (sales) of Kotak Commodities. Futures, unlike ETFs, allows you to take physical or demat delivery where the physical gold is stored with the custodian and a credit is received in your demat account. You will have to pay a 1% charge for vaulting and insurance. Overall, the impact cost of buying, selling and storing is too high and is a relatively cumbersome proposition. As Mashruwala says, the option is better suited for speculation rather than for long-term investment.Tax implications
Gold funds are more tax-efficient than physical gold. If held for more than a year, these funds qualify for a long-term capital gains tax (LTCG) of 10% compared to a three-year holding period for physical gold after which it qualifies for LTCG tax at the applicable tax rate. Also, holding physical gold of more than Rs 15 lakh attracts a wealth tax of 1% of the gold value at the end of every year.'
In terms of returns, globally, analysts expect gold to remain in the range of $850-1,000 an ounce for major part of this year. Clearly, global inflationary concerns, increase in world gold demand with no new mining capacity coming through, and new investment demand from ETFs, will continue to be the drivers of gold prices. “Despite the phenomenal rise, we feel gold is still undervalued in real and relative terms and expect it to touch $1,400 by mid 2011”, says Patnaik. From the current level of $950, this translates into a compound annual growth rate of 14%.
However, you must keep in mind that over the long term, gold may not outperform other asset classes like equities. “Gold has been known to move in line with inflation and is clearly a protector of money rather than being a creator,” says Jhaveri. If you are a gold investor, you should hold on it purely with the objective of portfolio diversification and as insurance against global economic instability. Gold is less volatile than equities, and so might never correct as sharply as other markets. Analysts suggest that you maintain an exposure of not more than 10-15% to gold. Even that is bound to make your portfolio shine.