New Delhi, India. November 22, 2010 – The debasement of currencies, particularly the US dollar, has given gold, perceived as a monetary unit, a leg up with the metal slated to record its tenth annual gain, the longest since 1920. With the US Federal Reserve set to pump $600 billion through purchase of debt, more money is expected to chase commodities such as gold. Furthermore, recent purchases by a few Central Banks have added to its appeal.

In such a situation, it is not surprising for investors to have been bitten by the gold bug. According to Gnanasekar Thiagarajan, Director, Commtrendz Research, gold is the safest haven in uncertain financial world.

Given the fragile recovery in Europe and the US, investors around the world remain cautious and may continue betting on the diversification benefit of gold. Indian investors’ fascination for holding gold in a physical form seems to be decreasing as more people are buying gold for investment purpose. The popularity of gold exchange-traded funds (ETFs) is increasing as more investors become aware of the benefits of investing in gold in a nonmaterial form rather than holding it as jewellery.

Gold ETFs are open-ended mutual fund schemes that invest the money collected in standard gold bullion. These are passively managed funds that closely track the returns from physical gold in the spot market. The asset under management (AUM) increased three folds from Rs 900 crore to Rs 2,700 crore over one year period, clearly indicating ETF’s popularity.

As liquidity in gold ETFs has increased significantly, impact cost (on gold ETFs) has reduced considerably. At present, there are nine different gold ETFs (gold-based ETFs) available for trading as well as investments on the National Stock Exchange (NSE). Some of them are Benchmark Gold BeES, UTI-Gold ETF, Kotak Gold ETFs and SBI Gold ETFs.

Gold BeES comes from Benchmark Asset Management Company, which is one of the oldest players in the Indian ETF sector. The return of Gold BeES is in tandem with the gold spot rate while most others have more than 1% of tracking error.

Investing in physical gold has some cost attached to it like cost of storage, liquidity and purity. On the other side, investing in gold ETFs can give the investor all the advantages of investing in gold while shielding him from drawbacks of physical gold. Investor can buy and redeem the units either directly from the mutual funds or from the stock exchange.

Gold’s appeal as an alternative investment option remains very high. Gold today has become a part of asset allocation as it gives diversification benefits to the portfolio. According to Anil Rego, CEO, Right Horizons, investors should invest 5-10% of their total investment portfolio in gold or gold ETFs. By balancing asset classes of different correlation, investors can hope to maximise return and minimise risks.

On the flip side gold ETFs has some disadvantages. Systematic investment plan is not available for gold ETFs. Investors can buy gold in the spot market as many times as they want without paying any front loading fees as in case of gold ETFs.

Investors should also give attention to various tax implications while investing in physical gold or gold ETFs. For physical gold, the short-term capital gains tax will be applicable till three years of holding. But in gold ETFs, for short-term capital gains tax to be applicable, the holding period is only one year. So its better to hold gold ETFs for more than on year.

Gold has negative correlation with the US dollar index. It simply means that gold prices and the dollar index tend to move in opposite directions. This suggests that a weaker dollar will be a key to watch for investors seeking invest in gold. Indian investors should also give attention to the behavior of Indian rupee vs dollar. Any increase in international gold prices may not translate into absolute returns if the rupee appreciates significantly against the dollar.

For more: The Economic Times, MJS Commodities


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