Investing In Gold
Investing in gold has been a reliable wealth preservation strategy for centuries. Indians living in far away rural villages to metro cities share equal love for the yellow metal. This precious metal is renowned for its ability to hedge against inflation and economic instability. This article will delve into the benefits and considerations of investing in gold, providing you with a mindful approach to this timeless investment.
Table of Contents
Gold As An Asset Class
Gold is the largest asset class in the world having more than $15 Trillion in market cap.
Rarity of Gold
Imagine all the gold ever mined throughout history could fit into a cube with sides of around 20 metres. This might seem like a lot, but considering the vastness of the Earth, it highlights the relative scarcity of gold.
Central Banks hold a large part of gold. They keep on buying gold every year that pushes up the gold prices. Top 3 holdings of gold with the central banks in the world.
- United States: About 8,133.46 tonnes
- Germany: Approximately 3,352.65 tonnes
- Italy: Around 2,451.84 tonnes
India holds the 9th position in terms of central bank gold reserves, with approximately 789.42 tonnes. Indians are globally at second position in gold consumption after the Chinese.
Why Invest in Gold?
Inflation Hedge
Gold has historically served as a hedge against inflation and other economic concerns. In comparison with paper currency, gold maintains its value over time, making it a safe investment during economic downturns.
Protection Against Currency Depreciation
Gold also protects against currency depreciation. Paper currencies can be printed at will but gold’s limited supply and inherent value make it hold its worth over time. This is the reason the Central Banks of the world like to hold gold.
Portfolio Diversification
Incorporating gold into your investment portfolio can enhance diversification. Gold often moves inversely to the stock market, providing balance and reducing risk. It can provide stability to portfolios when the financial markets turn volatile.
Liquidity
Gold is highly liquid. Whether in the form of coins, bars, or ETFs, gold can be easily bought or sold in the local jeweller’s market, offering investors quick access to cash when needed. Demat gold can be traded in exchanges with ease. Banks also offer loans against gold as a collateral. Loans taken against gold as collateral are less expensive than personal loans.
Economic Uncertainty
Gold performs well during the environment of economic uncertainty. Gold also tends to do well when real interest rates are low. Gold prices also rise when geopolitical tension escalates. Central banks also heavily invest in gold to counter risks of economic crises.
Types of Gold Investments Sovereign Gold
Bond Scheme
The Sovereign Gold Bond Scheme (SGB) is a government-backed program offering an alternative way to invest in gold. SGB provides many advantages over investing in physical gold. It makes the investing and holding of the gold portfolio easy for even a new investor.
They come with a guaranteed 2.5% annual interest and maturity amount is also tax free. SGBs are traded in demat form, similar to stocks and bonds. This eliminates the need for physical storage and makes transactions easier. However, SGBs lock your money for 8 years (with an option to exit after 5 at market price).
Gold ETF
Gold Exchange-Traded Funds (ETFs) are a popular way to invest in gold without owning physical gold. They offer the benefits of gold investment with the convenience of stock trading. Gold ETFs invest in physical gold of highest purity and aim to track the domestic price of gold. Minimum investment requirement in gold etf is very low (0.01 gramI). ETFs make sense for investors looking to make a medium term investment in gold.
Gold ETF are traded in stock exchanges. They do not have a lock-in. ETFs are fairly liquid if bought from an AMC with decent AUM. Investors can buy and sell anytime during the market hours. Gold ETFs can be bought in small quantities which makes it easier for retail investors to build up their gold portfolios gradually. In contrast with physical gold, there is no storage or safekeeping cost associated with Gold ETFs. However, investors need demat accounts to buy the ETFs and have to pay 1% to 2.5% expense ratio.
Long term capital gain benefits have been withdrawn from Gold ETFs and gold mutual funds. From FY 2023 onwards, capital gains from gold ETFs are taxed at the tax slab rate of individual investors.
Investors should be aware that the price of gold EFF is affected by the trading pattern ( status of number of interested buyers and sellers available for any specific price point) at any particular time.
Gold Mutual Funds
Gold mutual funds pool money from multiple investors to invest in a diversified portfolio of gold-related assets. Gold fund of funds invests in gold ETFs. Mutual funds are suitable for those investors who want to build up their gold investment portfolio using systematic investment plans (SIP). There is no requirement of having a demat account to invest in mutual funds.
From FY 2023, capital gains from gold MFs are taxed at the tax slab rate of individual investors.
Those who want to stay invested for less than 5 years, can invest in gold ETFs or mutual funds.
Physical Gold
Investing in physical gold involves purchasing gold coins, bars, or jewellery. This form of investment provides tangible assets but also requires secure storage and insurance.
Physical gold is the most preferred option for gold holding. More than 45% of total mined gold in the world is held in the form of jewellery. Bullion like coins and bars are easy to sell. However, there are various issues related to physical gold like purity issues, storage cost, lower resale value, retail markups etc. jewellery has an additional expense of making charge which is deducted when someone sells it back to the jewellers. Jewellers may reduce the value of jewellery by 10% when buying it back from customers.
Physical gold is useful for those investors who want to safeguard themselves against extreme scenarios like closure of whole financial markets or failure of national government. The best way to invest in physical gold is through gold bars and coins. Price of these forms of physical gold is usually 10% higher than the general market price of gold. Melting fees have to be paid to the jeweller while selling the gold bars and coins.
Whenever purchasing jewellery always go for hallmark jewellery, in this case jewellers charge a price that is close to the current market rates. Gold jewellery is good for personal use but it must be avoided as investment in gold. These have a higher premium on the gold price than the gold bars and coins. Based on the intricate design of a jewellery, a considerable amount is charged from the buyer as jewellery making charge. This charge will be deducted when you want to sell the jewellery back to the jewellers.
Gold Mining Stocks
There are no major gold mining companies listed on the Indian stock exchanges. This is because India has very limited gold reserves. However, there are several companies that are involved in the gold business in India. Hindustan Zinc Limited is primarily a zinc and lead miner, but it also mines some gold. Vedanta Limited has a subsidiary that mines gold in South Africa. Rajesh Exports is a gold exporter and refiner. Stocks of jewellery manufacturing businesses such as Titan, Kalyan Jewellers, Senco Gold etc are a better way to benefit from rising gold demand in India.
Electronic Gold Receipts
EGR are depository gold receipts traded on the stock exchanges. Under this form investors buy gold in dematerialised form and are issued gold receipts instead of physical gold.
Parameter | Physical Gold | Sovereign Gold Bonds | Gold Mutual Fund | Gold ETF |
Return | Low (cost of safety, purity issues etc) | Gold price at the time of redemption, and 2.5% annual interest | Linked to gold prices. | Prevailing gold prices – expense ratio paid |
Safety | Risk of theft | High | High | High |
Liquidity | Restricted | Premature exit after 5 years; reselling on exchange is also available (but liquidity may be low) | High, Investors have to be aware of exit load | Can be traded on exchanges (depending on liquidity) |
Taxation | 30% if sold before 3 yrs; 20% with indexation after 3 yrs. | Interest is taxed at a marginal slab rate. capital gains tax (CGT) in case of premature exit; Maturity proceeds are tax free if held till 8 years. | Gains are taxed at marginal slab rate. | Gains are taxed at marginal slab rate. |
Factors to Consider
Market Trends
Gold prices can be influenced by various factors, including economic data, geopolitical events, and currency fluctuations. Staying informed about market trends is crucial for making informed investment decisions.
Several other factors influence gold prices in India. A weaker Indian rupee against the US dollar can make gold more expensive domestically, as gold is typically priced in dollars. Additionally, inflation rates, interest rates, and government policies, such as import duties, significantly impact gold prices. Increased demand during festive seasons (such as Akshaya Tritiya) and weddings pushes up the price of gold in India.
Storage and Security
Physical gold requires secure storage solutions to protect against theft. Consider the costs of safe deposit boxes, bank lockers or private vaults when investing in physical gold.
Home safes, while convenient, can be expensive to install and maintain, and they may not provide adequate protection against sophisticated theft attempts. Bank lockers and professional vault services, on the other hand, come with annual fees that can add up over time. Moreover, there’s always the risk of losing access to these storage options due to unforeseen circumstances. Insurance is another cost to consider, as it is essential to cover the value of the stored gold against theft or damage.
Costs and Fees of investing in Gold
Investing in gold involves various costs and fees that can affect the overall returns. Price physical gold is usually higher (including GST charges) than other forms of gold. For gold ETFs or mutual funds, management fees (expense ratio) are charged, which can range from 0.25% to 2% of the investment value annually. Additionally, transaction costs such as brokerage fees apply when buying or selling gold-related securities. Therefore, it’s essential to consider these factors and choose the most cost-effective investment method to maximise returns.
Risks of Investing in Gold
Price Volatility
Investing in gold comes with the inherent risk of price volatility. Gold prices can fluctuate significantly due to various factors such as changes in global economic conditions, inflation rates, geopolitical tensions, and shifts in supply and demand. These fluctuations can lead to unpredictable gains or losses for investors.
Strategies for Managing Volatility
To manage the volatility associated with gold investments, investors can adopt several strategies. Diversifying their investment portfolio by including a mix of asset classes (stocks, bonds etc) can help mitigate the impact of gold price swings. Additionally, investing in gold through instruments like ETFs or mutual funds can provide more stability (professional management, diversification, cost efficiency, accessibility, and price transparency etc) and liquidity compared to holding physical gold. Regularly monitoring the market and staying informed about economic indicators can also help investors make timely decisions to minimise risks.
No Yield From Gold Investing
Gold does not generate income (dividends or interest payments), which has significant implications for any investment strategy. Only SGB pays an annual interest. Investors seeking regular income might prefer stocks and bonds, whereas gold is valuable for diversification and protection against economic uncertainty. While gold stabilises a portfolio during market downturns and appreciates over time, it should not be relied upon for immediate returns. A balanced investment strategy should include a mix of growth assets like gold and income-generating assets like stocks and bonds to achieve a comprehensive and effective portfolio.
Economic Factors
Economic factors play a crucial role in gold investing. Interest rates significantly impact gold prices. Lower rates often boost demand for gold as alternative investments generate less returns. When real rates are rising, investors put more money into debt instruments than to a non interest bearing such as gold. Government policies, including regulations on gold imports and exports, taxes, and monetary policies, also affect gold’s attractiveness and availability. Monitoring global economic conditions is essential for gold investors, as economic instability or geopolitical tensions can drive gold prices up, making it a safe haven asset during uncertain times. Staying informed about these factors helps investors make informed decisions about buying or selling gold.
Final Thoughts
Since gold doesn’t offer consistent returns every year, investors need to have a longer term allocation to it. investors should hold gold for at least a 7 year period. Investors may maintain 5 to 10% allocation to gold in their portfolios. If you don’t have that allocation then gradually acquire gold over an extended period of time. Avoid lump sum purchases after a price rise. invest in parts whenever there is a dip in the gold price or buy gold via systematic investment plan. Gold ETF have a lower expense ratio that enhance your return.
Investing in gold can be a very useful addition to an investment strategy. Its ability to hedge against inflation, provide liquidity, and enhance diversification makes it a worthwhile consideration. However, it’s essential to understand the various investment options, associated costs, and potential risks. By approaching gold investment mindfully, you can make informed decisions that align with your financial goals.