Gold Exchange Traded Funds Vs physical gold

I am considering investing in Gold ETFs. How are Gold ETFs better than investing in physical gold?

- M Padma, Rajahmundry

In 2003, the world's first gold ETF was launched in Australia, the first country to accept the idea of investing in a precious metal in electronic form. Benchmark Mutual Fund was the first fund house to launch Gold ETF in India on 8th March, 2007 to commemorate International Women's Day, one of the most important days to celebrate women's achievements and raise awareness for women's equality. At last count, gold ETFs were worth over $218 billion as of February 2023, and Gold ETFs are one of the most popular ETF products now. A Gold ETF is an exchange-traded fund that tracks the domestic physical gold price. Exchange Traded Funds are passive investment instruments based on real-time gold prices and investing in gold bullion. In a nutshell, Gold Exchange Traded Funds (ETFs) represent physical gold in electronic or dematerialised form. One Gold ETF unit is equal to one gram of gold. Gold ETFs are backed by physical gold of very high quality and purity. Gold ETFs combine both the features of the simplicity of gold investments and the flexibility of stock investment.

Gold ETFs are listed and traded on the Bombay Stock Exchange Ltd (BSE) and the National Stock Exchange of India (NSE), like the equity shares of a listed company. Gold Exchange Traded Funds are traded on the cash segment of BSE and NSE, similar to any equity share or a mutual fund, and can be invested, traded, purchased and sold at stock exchanges at real-time market prices.

Investing in Gold ETFs means investors are purchasing gold in dematerialised form or electronic form. When the investors withdraw from the ETFs by selling units or redeeming units of Gold ETFs, they do not get physical Gold. Investors who redeem the Gold ETF units will receive the cash equivalent as per the prevailing NAV (Net Asset Value) of the redemption date.

Demat (dematerialised account) is a must for buying, selling or trading in Exchange Traded Funds. It is extremely easiest and most convenient to invest electronically in Gold by taking the ETF route. The most distinguishing quality of Exchange Traded Funds is transparency. One can know what holdings are in an ETF and in what weighting on a daily basis. Because of the Exchange Traded Funds' unique structure and creation mechanism, ETFs have much lower expenses than physical gold investments.

Valuation:

Since physical gold and other permitted instruments linked to gold are denominated in gold tonnage, it will be valued based on the market price of Gold in the domestic market and will be marked to market daily. The market price of Gold in the domestic market on any business day would be arrived at as under:

The domestic price of Gold = (London Bullion Market Association AM fixing in US$/ounce X conversion factor for converting ounce into kg for 0.995 fineness X rate for US$ into INR) + custom duty for import of gold + sales tax/octroi and other levies applicable.

The Trustees reserve the right to change the source (centre) for determining the exchange rate. The AMC shall record in writing the reason for a change in the source for determining the exchange rate.

Determination of Net Asset Value:

The Net Asset Value (NAV) shall be calculated up to four decimals. The Net Asset Value of units under the Scheme shall be calculated. NAV (Rs) = Market or Fair Value of Scheme's investments + Current Assets Minus Current Liabilities and Provision/ Number of Units outstanding under the Scheme on the Valuation Date.

Purity and Price:

Gold ETFs are represented by 99.5 per cent pure physical gold bars. They can be bought or sold anytime through a stock broker at real-time prices listed at BSE and NSE. The brokerage firms charge a fee or fund management charges when buying and selling Gold ETFs. Unlike physical Gold or jewellery, units of Gold ETFs can be bought and sold at the same price nationwide.

Tax and Taxation:

Investors or Gold Exchange Traded Fund unitholders will have to pay capital gains tax upon making profits from the redemption of Gold ETF units. Taxes are applicable on both short-term and long-term capital gain based on the holding period. While short-term capital gains before the three-year holding period are added to the investor's income and taxed as per the existing slab rate. Long-term capital gains tax is taxed at 20 per cent after indexation on gold ETF investments held for over 36 months.

Risks and Rewards:

Gold ETFs are subject to SEBI Mutual Funds Regulations. SEBI mandates that the Gold ETF fund houses conduct a regular audit of the physical Gold held by fund houses. Gold Exchange Traded Funds are subject to market risks impacting the price of Gold. Gold ETFs are ideal for investors who are unwilling to invest in physical gold due to the purity of gold, storage of gold and various reasons, hassles and risks associated with physical gold. Gold ETFs suit these kinds of investors as they need not pay any making charges to gold shops and locker charges to banks. Moreover, one can purchase as low as one unit is equivalent to one gram. Gold Exchange Traded Funds are transparent.

Gold is considered a safe asset, which means that its prices are usually not very volatile. A great advantage of Gold lies in its liquidity. It is a highly liquid asset class, and one can get loans against Gold. However, physical Gold may sometimes face liquidity risk or become less liquid and more difficult or costly to sell. Gold ETFs that track Gold are highly liquid and cost-effective.

(The author is a SEBI licensed Research Analyst. The alumnus of the Indian Institute of Foreign Trade (IIFT), he had held leadership roles at National Geographic, Reliance Radio Television Luxembourg, STAR TV)