A fund that could glitter

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The recent Budget decision to introduce Gold Exchange Traded Funds with `gold' as the underlying asset will facilitate buying and selling of the yellow metal even in the smallest of units. This is a welcome move that signifies India is catching up with the developed markets.

A golden opportunity: Gold ETF (Exchange Traded Mutual Fund Units) will facilitate hedging and arbitahe opportunities apart from providing traders with a more transparent platform. K.K Mustafah
A golden opportunity: Gold ETF (Exchange Traded Mutual Fund Units) will facilitate hedging and arbitahe opportunities apart from providing traders with a more transparent platform. K.K Mustafah

A. K. Sridhar

INDIA's obsession with gold is well known. So much so that till about 15 years ago, the yellow metal was synonymous with smuggling. But things changed in the reform era when gold imports were allowed freely. Now, New Delhi is contemplating introducing Gold Exchange Traded Funds (ETFs) a fairly new idea even in the US. It was heartening to hear the Finance Minister say in his Budget speech that we were now in a position to introduce `gold units' and create a market for them.

About a decade ago, India embarked on the exercise of ensuring that gold inflows were through the official channels alone.

Now, the Government is showing its interest by asking/letting the Securities and Exchange Board of India to permit mutual funds to introduce Gold Exchange Traded Funds (GETFs) with `gold' as the underlying asset.

This will enable many households to buy and sell gold in units for as little as Rs 100. Such units can be traded in the same manner as units of mutual funds.

Remember, these Gold ETF units represent pure 24 carat gold against the street-corner jeweller calling any metal that is yellow in colour `gold'. The mutual funds industry will surely welcome this step, which underlines the pace at which India is catching up with the developed markets. The first Gold ETF was launched in 2004.

Gold ETF typically is an Exchange Traded Mutual Fund Unit listed and traded on a stock exchange. Gold is the underlying asset for the units of that fund.

Every Gold ETF Unit represents a definite quantum of pure gold and the traded price of that Gold Unit moves in tandem with the price of the actual gold metal as is traded in any big gold merchant or in any metal exchange.

A mutual fund house launching a Gold ETF appoints Authorised Participants who initially buy the units of Gold ETF from the mutual fund by exchanging actual pure gold for the units of Gold ETF. These Authorised Participants facilitate secondary market trading through of the Gold ETF Units through the Stock Exchange, where investors can buy or sell gold units on payment, for quantities as small as one unit.

The underlying asset that is, gold is held by a mutual fund house issuing such units either in a physical form or through a `gold receipt' giving right of ownership. Authorised participants can go back to the mutual fund house to redeem the gold ETF Units and can demand equivalent value of actual pure gold at any time.

The experience abroad

While gold funds have been operational in the developed markets for some time, Gold ETF is a recent development. `StreetTRACKS Gold Trust' is the first Gold ETF marketed by `State Street Global Markets' (SSgA) LLC and sponsored by the World Gold Council. The Fund mopped up $550 million. Incidentally, UTI Mutual Fund in India has a tie-up with SSgA as an investment advisor for investing in overseas market whenever such products are launched.

A second gold ETF has been submitted to the US Regulator for approval by Barclays Global Investors. It will be known as the `iShares Comex Gold Trust' and will be listed on the American Stock Exchange under the symbol "IAU."

Like the `StreetTRACKS' Gold Trust, the `iShares' Trust's share price will be equal to one-tenth of the spot price of one ounce of gold.

Opportunity for Indian investors

In India, traditionally gold is acquired in the form of jewellery, which is most often passed on from one generation to another, and is thus also a significant means of saving for the family. India is the world's largest consumer of gold jewellery. It accounts for 20 per cent of the global gold offtake in any year.

An estimated 13,000 tonnes of gold rests in India, which is about 9 per cent of the global cumulative mine production. Banks and specified agencies are allowed to import gold; they later sell it to the domestic wholesale traders, fabricators and industrial consumers.

Export oriented units and units in SEZs are also allowed to import gold directly. The price risk is borne by the fabricator or the consumer. Recently, gold imports were allowed under Open General Licence.

Gold ETF will provide an additional transparent platform for traders, fabricators and jewellery manufacturers to take long or short positions on the metal and also facilitate hedging and arbitrage opportunities.

For the retail investor, it will facilitate easy buying of standard quality gold in small units without the hassle of safekeeping of the precious metal and cost of insurance.

Gold ETF have the potential to increase mobilisation of gold and are expected to increase hallmarking of the metal.

Regulated mutual funds with strong brand identity would provide comfort for retail investors to deal in gold through them.

Issues that need attention

Globally, the gold market is overseen and regulated by both governmental and self-regulatory organisations. In addition, certain trade associations have established rules and practices for market participants, for example, the London Bullion Market Association (LMBA) for British markets. In India, a regulatory framework is in place.

As there is no self-regulatory organisation in the mutual fund industry, trade associations under the overall legal framework of the regulator, need to assume a much greater role to ensure fair market practices in respect of purity and other standard specifications.

Other issues such as liabilities and responsibilities of the participants including the custodians, valuations, benchmarking, fees and expenses, capital adequacy norms and counter-party risks are also very important. There are methods to reduce the cost of import, transportation and insurance costs by possibly choosing custodians who are nearer to the place where the actual gold is procured. The lower the cost of operations, the greater will be the popularity and trading of gold ETF units.

This Budget announcement of gold ETF is a small beginning of what could possibly change the way in which the Indian public has been looking at their family wealth that has been lying idle in the form of gold.

And, in a few years, the phrase `Born with a Gold ETF spoon' may become common parlance. Amen to that.

Why invest in Gold ETFs

GOLD ETF will provide a screen-based platform to investors to accumulate quality gold in small lots. For example, a father wanting to gift gold to his daughter need not buy the metal (or the jewellery) only when he intends to gift it to her, instead he can start buying in small lots.

This reduces the strain on one's budget. Unlike in the case of chit funds, which package a gold purchase at a future date for its members at the price prevailing on the date of purchase, Gold ETF will facilitate locking standard quality gold at current price points.

Gold has proven to be a good hedge against inflation and maintained a long-term value. Gold is not highly correlated with other financial assets such as stocks, currency and bonds, which are directly affected by the country's economy.

Hence, it offers a good diversification and reduces overall risk/volatility of investments.

Gold has a ready and wide acceptability. Hence, exchanging it for cash or raising money against gold is easier.

Gold ETF backed by the standard hallmark quality can provide a safe and liquid investment avenue though price volatility in the short term cannot be eliminated.

(The author is Chief Investment officer, UTI Mutual Fund. The views are personal.)

(This article was published in the Business Line print edition dated March 6, 2005)
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