10 things you must know about buying Gold ETFs

Gold Exchange Traded Funds (ETFs) are units of gold that are issued and the ETF holds physical gold against it with a gold custodian bank. In India, Gold ETFs have been around for over 10 years in India but they are yet to take off in a big away especially considering that gold prices have been on a secular downtrend since September 2011. In terms size, the Indian Gold ETF segment is miniscule compared to the global ETF industry. The entire Indian gold ETF AUM is less than $1 billion whereas the world’s largest gold ETF, Spider Gold ETF, alone manages over $35 billion AUM. Here is a snapshot of some of the largest gold ETF managers in the world..

 

                                                Source: ET DBF

 

What is Gold ETF and how does it work? There are certain basic things you need to understand before you invest in gold ETF in India. Let us also understand the scenario of gold ETF investment in India. Here are 10 things that you need to understand about the nuances of investing in Gold ETFs..

 

1.  Gold ETFs is just one of the option to invest in gold

There are a variety of methods to invest in gold. You can opt to buy physical gold in the form of bars, you can buy gold bonds issued by the RBI, you can also buy e-gold that is issued by commodity exchanges or even put your money in gold futures. One of the advantages of Gold ETFs is that it can be held in your regular demat account and can be bought and sold like any stock. Gold ETFs are fairly liquid in India.

 

2.  Gold ETFs can be bought and sold in exchanges like a stock

This is a corollary to the previous point and you can actually buy and sell gold ETFs on the normal stock exchange using your existing trading account. Like in case of shares, these Gold ETFs will get credited or debited to your demat account and has no lock-in requirements.

 

3.  Gold ETFs buying or selling does not impact the AUM of the fund

This is where gold ETFs are unlike a normal mutual fund. When you buy units of a mutual fund scheme from the AMC, the AUM of the fund increases and when you redeem units the AUM of the fund reduces. In case of ETF, there is only transfer of ownership from seller to buyer and the ETF AUM remains constant.

 

4.  Gold ETFs are backed by actual gold kept with the gold custodian

In case you are worried about what happens to your money, remember that gold ETFs are regulated by SEBI and every unit is backed by physical gold. Normally, gold funds tend to keep their physical gold in custody with Bank of Nova Scotia. What you need to be assured of is that every unit of gold ETF is secured by equivalent physical gold.

 

5.  Gold ETFs are pegged to the price of gold

There is a price risk in gold ETFs just as there is price risk in gold. If the price of gold goes up then the price of the gold ETF also goes up and vice versa. There is no other factor that impacts the price of Gold ETF other than the price of physical gold. The largest gold ETF in India, GOLDBEES, operates at a fraction of 1 gram of gold.

 

6.  Gold fund provide you diversification from equity holdings

Gold and equity normally have a very low correlation or at times they even have negative correlation. That is why including gold in your portfolio to the extent of 10-15%, gives you a hedge against the vagaries of the macroeconomic risks and stock market volatility.

 

7.  Gold ETFs work best in times of global uncertainty

This is something that you will get to see time and again. Gold prices tend to increase in times of economic and geopolitical uncertainty. Through the seventies when the world was rocked by wars, the price of gold shot up almost 25 times. Post the Lehman crisis, the price of gold continued to go up till September 2011 when it finally topped out. Gold is a good hedge in times of elevated global uncertainty.

 

8.  Gold ETFs are subject to capital gains tax like any other asset

Gold ETFs are subjected to capital gains tax when it is redeemed. There is a small difference here. Gold ETFs are treated as non-equity assets and hence their definition of short term will be 3 years instead of 1 year. Also, LTCG will continue to be taxed at 20% after considering the benefit of indexation.

 

9.  STT is not applicable in case of Gold ETFs

Gold ETFs are not required to pay Securities Transaction Tax (STT). That is because STT is only imposed by default on equity and equity products. Since gold ETFs are explicitly classified as non-equity products, they do not attract STT. That actually improves the redemption yield on gold ETFs.

 

10.  Gold ETFs are a hedge not an investment

This is perhaps the most important point that people need to understand about gold ETFs. They are not investments like equity or debt that can create value over a period of time. They are hedges. That means they are meant to protect value in times of political and economic stress when other asset values are facing pressure. Click here to know more about What is the difference between gold ETFs and gold mutual funds

Gold ETFs are an asset class you must consider to give protection to your portfolio. Once you grasp these basics, you are good to allocate a part of your portfolio to gold ETFs.