The love for gold in India is legendary. Apart from Bank FDs, it has historically been one of the most preferred ways of investing one’s money. This is especially true of the rural areas, where even the penetration of banks is low; forget about equity, mutual funds, etc. Thus, there has always been a good demand for gold in India making it the largest consumer of gold in the world.

Recently, factors such as (a) the volatility in the equity markets worldwide, (b) concerns of the US recession, (c) inflationary pressures due to high oil, commodities & food prices and (d) weakening dollar, have generated a lot of interest for gold amongst the investors the world over.

Therefore, in just 2 years we have seen the prices of gold more than double from around 6000 levels in early 2006 to more than 12,000 recently.

Traditionally, the only option available to buy gold was in the physical form – whether as jewellery or as bars/coins. But with the launch of Gold Mutual Funds (i.e. the Gold Exchange Traded Funds), we now have an alternative of buying gold in the demat form.

Therefore if someone were interested in buying gold, he would need to broadly answer two questions:
(a) Should one invest in gold and
(b) If yes, then which is better – Physical gold or Gold ETF?

Since the answer to the 2nd question is simpler, let’s take that first.

Physical Gold or Gold ETF?

In case gold is being bought purely for investment purposes, then Gold ETF scores over Physical gold.

• Low cost: When you buy Gold ETF you have to pay only the brokerage charges, which is usually around 0.5%. Vis-à-vis this, you may have to shell out anything between 10 to 20% as premium and/or making charges if you buy physical gold. To store physical gold, you have to incur locker/insurance charges, while in ETFs one pays the annual fund management charges of 0.5-1%. Though physical gold kept at home with no insurance can save annual costs, it is quite risky.
• Transparency: For ETFs, the rates are quite transparent as they are linked to the international prices. But there is no commonality in prices of gold across various jewellers/banks even within the same city.
• Purity: You need not be concerned about the purity of gold in Gold ETF.
• Security: No one can steal your Gold ETF units.
• Capital Gains Tax: In case of physical gold the LTCG tax becomes applicable only when the holding period exceeds 3 years. This limit is just 1 year in case of Gold ETFs.
• Wealth Tax: Physical gold attracts Wealth Tax whereas Gold ETF is exempt from Wealth Tax
• Convenience: Just call up your broker and your job is done. You don’t need to visit the nearest jeweller with loads of cash.

Thus Gold ETF offers a convenient, safe and hassle-free way of investing in gold besides lower expenses as compared to buying Physical gold. However, if the gold has to be used as jewellery also, then of course there is no choice.

• Check out - How Gold Funds are performing?

As regards choosing between a jeweller and a bank, the next-door jeweller is usually a better option as presently the banks can only sell gold but cannot buy it back and the premium also could be higher.

Is Gold a good investment?

This question does not have an easy answer. There are both proponents and opponents to investing in gold. Gold is essentially a game of demand and supply. And it is not easy to predict the demand-supply scenario because of multiple factors – both national and international - affecting it.

But if we look at the past 15-20 years’ record, it is seen that Gold is a hedge against inflation. Over the last 20 years, the average return from Gold has been around 7% as against 16-17% from equity.

But if one were to look at annual (YoY) returns over the last 2 decades (1988 to 2007) based on the prices prevailing as at the end of each year, we find that of the 20 such observations, 3 were negative (e.g. 1993: -5%, 1998: -17% and 1999: -2%). Similarly, 11 times the YoY returns was between 1-7%, 3 times between 11-17% and 3 times between 26-33%.

So, if the past trend continues, one could expect around say 6-9% returns from gold in the long-term. In the short-term the scenario can be quite volatile. There can be both high gains and high losses depending on how the short-term factors play out.

Concluding, therefore, it could be said that one may invest a small portion of one’s corpus in gold as a means of portfolio diversification. But one should not expect high returns, especially the kind of returns we have seen in the recent past. Equities and Real Estate would still be a better bet for wealth creation.

- Sanjay Matai

The author is an investment advisor and promoter of wealtharchitects.in. He can be reached at sanjay.matai@moneycontrol.com.

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