There are several options today for someone who wants to invest in gold. You could buy physical gold (as bars or coins) or in proxy form, as gold ETFs (exchange-traded funds) or gold fund-of-funds or as gold bonds. Here’s what you need to know about the various options, the costs associated with the investments, and the returns one might reasonably expect:
Many Indian families abide by the tradition of buying gold coins for festivals and on other auspicious days. Until a few years ago, all banks were selling gold coins, but in 2013, when the country’s current account deficit was ballooning, the government initiated a series of policy measures to disincentivise gold imports. It imposed higher import duties and placed other restrictions on gold imports in order to curtail the dollar spending on gold. Additionally, the Centre also enforced restrictions on banks and post offices from selling imported gold coins. Today, most other restrictions on gold have gone, but banks are still restricted from selling imported gold coins. However, they now sell Indian gold coins. These coins have the national emblem, the Ashoka Chakra, engraved on one side and Mahatma Gandhi on the other side. The coins are hallmarked by the Bureau of Indian Standards, and are of 999 fineness and 24-carat purity. These coins are minted by the Indian Government Mint, and can be purchased directly from MMTC outlets.
Additionally, the Stock Holding Corporation of India and some of the non-banking financial companies, such as the Muthoot Group (through its arm, Muthoot Precious Metals Corporation), sell gold coins.And, of course, so might your friendly neighbourhood jeweller.
But there are add-on costs associated with buying gold coins and bars. There are making/wastage charges, processing fees, packaging costs, and so on. When you buy from a jeweller, you will pay making charges of about 2-4 per cent on the gold coin. If you buy from a bank, there will additionally be processing charges, which vary from bank to bank. For all that additional cost, you get the vicarious pleasure of holding physical gold in your hands. But that also comes with the downside risk—of the security of your holding.
Taking the mutual fund route to investing in gold—through ETFs or gold fund-of-funds—spares you the agony of fretting about safekeeping of the precious metal. You can buy and sell gold (in proxy form) through these funds, which are listed on an exchange. When gold prices go up, so does the value of your investment in the ETF or the fund-of-funds. In this way, you get an exposure to gold without taking physical possession of gold. It works pretty much in the same way that you invest in professionally managed equity mutual funds as a proxy for investing directly in stocks. And yet, gold ETFs are backed by physical gold: that is, when an investor purchases a gold ETF on the exchange, it is backed up by purchase of physical gold at the back end.
Note that you will still incur additional costs in the form of fund management fees and brokerage (if you buy gold ETFs). Additionally, mutual fund portfolios are susceptible to “tracking error”, which is the difference between the fund portfolio’s returns and the benchmark index it was designed to mimic. Typically, when gold prices fall, and there are heavy outflows, the tracking error can be high.
In recent years, and particularly following the launch of sovereign gold bonds, gold ETFs have lost a bit of their sheen (see page 14).