Investors' Hangout: Is it the right time to invest in gold?

What's the case for investing in gold?

For 20 years, I've advised people against gold; it's not an asset. However, in recent times, central bankers have been buying gold, which has made it an interesting diversification.

The real reason behind this is to insulate themselves from the risk of fiat currencies. So, gold is taking up the role of a currency that has some intrinsic worth and has the potential to become a superior store of value. This rising demand is translating into returns, and that's why I think it will sustain itself.

The second reason why I think gold is an interesting choice is that we are seeing a unidirectional market. Governments all over the world are printing money, and they're borrowing, so debt has become increasingly vulnerable.

The first time gold came into prominence was a little before 2008, during financialisation of gold. It became possible to buy a gold ETF or have proportionate ownership of gold without physically owning it; this facility allowed you to ride gold prices.

Suggested read: A comparison between a gold fund and a gold ETF

2008 was a landmark year for gold as an investment, as that was when equity markets and fixed-income collapsed, especially in America. It was the only asset that was appreciating amidst the Global Financial Crisis.

This is how the case for gold was built. All those variables remain in place today, so the case remains valid. That's why it's a meaningful diversification, and it will hold its value.

So, consider gold as a hedge, not as your primary investment. I've changed my view but that doesn't mean gold should be the only thing in your portfolio. Have a bit of gold because it is an investment that is completely uncorrelated to equity and debt.

Suggested read: Gold prices are rising. How high will it climb?

What are gold ETFs?

When you invest in an equity fund, you give your money to a fund manager, and he buys equities. When you buy a debt fund, the same principle applies: the fund manager buys debt instruments. However, a gold fund has a single investment, which is gold.

You give your money to a gold fund, and the fund manager buys gold. The ETF format of a mutual fund means that the fund gets created, and then different people who own that gold fund can sell it in the market. So, you buy it from the market, not directly from the fund house. This is the basic design of any ETF.

Now, let me highlight the difference between an ETF and a mutual fund. When you buy a mutual fund, you give your money to the fund house, and it issues units to you. When you buy an ETF, you place your order with a stock broker, who then matches your order with a seller who already owns that ETF.

So, you are buying from someone who already has the gold fund. ETFs can be created and cancelled, which means there isn't a significant premium or discount to them. Most investors should view a gold ETF as a gold fund that you buy through a stockbroker.

Is now the right time to increase exposure to gold ETFs?

There are different ways to hold gold. One way is through sovereign gold bonds (SGBs), which the government has been issuing. The reason they created SGBs is that they did not want investors to buy physical gold because that's an unproductive asset.

With SGBs, you follow the price of gold and get an additional 2.5 per cent return. After eight years, whatever appreciation there is, it is completely tax-free. However, because gold prices have gone up so dramatically, the government seems to be discontinuing these issuances.

The last issue was last December, so it's been eight or nine months. Previously, there used to be a new issuance every two to three months.

You can still buy them because they're listed on the market, but buying them from the market is no longer an option because the market price is at an 8-10 per cent premium to gold prices. It doesn't make sense to buy at that premium unless you think gold prices will increase dramatically, making it worthwhile to pay that premium for the remaining maturity of these bonds.

Suggested read: Why SGBs are burning bright and if it's a good time to invest in them

Physical forms of gold, like jewellery, are among the least efficient ways to own gold as an investment due to making charges and other costs. If you look at jewellery as a consumption item, it's different. But if you consider gold purely as an investment, jewellery, bars, and coins are less ideal due to liquidity and purity issues. If you have too much physical gold, there are also security concerns.

Non-physical forms of gold include gold ETFs, gold funds, and SGBs. SGBs purchased from the market are now ruled out because they are at a 10 per cent premium.

Every gold fund created invests in a gold ETF, so it's basically created for convenience. Most ordinary investors, if they want to buy gold in a financial form, can opt for the gold fund. They don't need a demat account or have to go to the market.

If you have a demat account and an account with a stockbroker, you can buy the gold ETF. Buying a gold ETF, however, may not always trade precisely at its NAV; it could waver depending on temporary market demand and supply mismatches. So, you need to be careful while buying these.

If you want to avoid this risk, buy a gold fund. There is a difference in cost between the two. Gold funds have two expenses, while gold ETFs have just one, but ETFs might not always be available at their NAV. So, there could be a cost implication.

Gold prices will appreciate or depreciate, and your return will be based on the appreciation or depreciation of gold prices minus the said expenses. The lower the expense, the better.

What are the potential risks investors should be aware of when considering gold ETFs?

Since gold ETFs are a financial form of gold, some risks associated with owning physical gold are reduced. You don't have to worry about purity or liquidity, as you'll be able to realise its value.

But, by and large, all the market risks remain. It's important to remember that while gold is often seen as a stable investment, there have been prolonged periods when gold has lost value. That's a risk investors need to be aware of.

Most other risks, such as liquidity and purity, are reasonably covered with ETFs. In India, gold ETFs have been around for a while, and most of its operational glitches or risks have been significantly reduced over the past 15 years.

Viewer's Question

Is investing in a conservative hybrid fund sufficient for one's debt allocation, or is a G-sec index fund or similar debt indices necessary?- Ganesh

If you're planning for a fixed-income allocation or investment for the long term, consider a conservative hybrid fund. This is because it will automatically rebalance and potentially generate more returns than a standalone fixed-income investment.

Suggested read: Rebalancing the Portfolio

If you are going to hold fixed-income for a very long period of time, choose a vehicle that will automatically rebalance. With two separate investments, there's a cost of rebalancing. Moving your money from equity to debt incurs a 12.5 per cent capital gains tax on the gains. Moving money from fixed-income to equity also means that all the gains will be taxable.

To save on taxes and keep things simple, it's useful to have a conservative hybrid fund as your fixed-income allocation. It's convenient, tax-efficient, and offers automatic rebalancing without any worries.

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Also read:
A twist in the gold story

This article was originally published on August 30, 2024.