How Gold ETFs hold an edge over physical gold for diversification
Source: Live Mint
Given the current gold prices and the average consumption over the past five years, India is expected to consume gold worth approximately $70 billion in 2025. While concerns over the widening current account deficit (CAD) persist, they often overshadow the broader perspective.
Gold continues to provide a buffer for Indian households during economic turbulence and volatility in risk assets. This resilience may explain why Indian households have historically weathered global economic crises better despite the absence of state-sponsored social security.
According to the World Gold Council, Indian households might be holding around $2.5 trillion ( ₹220 trillion) worth of gold. Gold prices have risen by over 38% in the past year, adding roughly $1 trillion to household wealth. This increase has provided a cushion against an almost trillion-dollar slump in Indian equities.
Although economists often lament that very little of this gold is liquidated to boost consumption, Indians tend to avoid selling gold due to cultural and sentimental attachments, as well as the stigma associated with selling one’s gold in India.
Enter gold ETFs
Gold Exchange Traded Funds (ETFs) present a compelling alternative. If even a fraction of Indian household gold holdings were in the form of gold ETF units, investors would benefit from superior liquidity and easier replenishment compared to physical gold. A government initiative encouraging 10-20% of all gold holdings in ETFs could enhance the productive use of gold and improve tax compliance. Additionally, gold ETF units could serve as an efficient form of collateral for asset creation.
Gold ETFs stand out as cost-effective, safe and liquid investment options. Investing in gold ETFs is as simple as swiping on your smartphone on an investment app.
Gold ETFs eliminate the need for physical storage, reducing the risks associated with theft and damage. The absence of making charges and purity concerns associated with physical gold adds to their appeal.
Gold ETFs are regulated by the Securities and Exchange Board of India (Sebi), ensuring a high level of investor protection and the structural benefits associated with mutual funds.
Sebi regulations require gold ETFs to buy gold as per the standards of London Bullion Market Association (LBMA). The gold bars must have a purity of at least 99.5% as per the LBMA standards. Fund houses appoint custodians to handle the physical gold, who appoint a vaulting agency to store the gold in vaults.
These ETFs are traded on stock exchanges, so investors can easily buy and sell during market hours. While physical gold is also liquid, it is not the same as gold ETFs, which can offer instantaneous buying and selling.
You can build your gold exposure gradually through gold ETFs. For instance, gold funds (funds of funds investing in gold ETFs) provide the added benefit of systematic investment plans (SIPs). This lets investors invest small, fixed amounts regularly. Apart from facilitating a gradual build-up, SIPs offer cost averaging. Essentially, you get more units when prices are low for the same SIP amount, which can bring down the average purchasing cost.
Unlike physical gold, you can buy a gold ETF for a fraction of the price. At current prices, you would need anywhere between ₹70-80 to buy a single unit of gold ETF. This is because several mutual funds have pegged their gold ETFs’ units to 0.01 gramme of gold price in the spot market.
Other costs
Each gold ETF has a different vintage, and over time, factors such as expense ratios, changes in customs duties, or local taxes impact its net returns. The expense ratios of gold ETFs also include charges for storage and handling of gold, as well as the insurance cover for the underlying physical gold.
Investors should assess the present market value of their ETF holdings to determine how much physical gold (in grammes) their investment is equivalent to.
The market value of an investor’s ETF units is equivalent to the same value in physical gold. For example, if the price of physical gold in India is ₹9,000 per gramme, an investor holding gold ETF units worth ₹27,000 owns the equivalent of three grammes of gold. Similarly, the total assets under management of gold ETFs represent the value of physical gold held under the scheme.
Highly liquid gold ETFs have the lowest impact costs (buying-selling spreads) and tend to track physical gold prices more closely on a real-time basis. Investors should also consider the credentials and reputation of the issuing asset management company (AMC). Choosing a reliable AMC ensures that global and domestic best practices in fund management are followed.
The views are personal.
Th author is head-commodities and fund manager at Nippon India Mutual Fund.
