Gold: Rising Prices and Investment

Audio Version Given Below

 

J P Morgan once said, “Gold and Silver is money, everything else is credit”.

Yes, that’s the importance this precious, glittering yellow metal has in the world, even though it is not used as money anymore. Possession of gold is not just an alternative for investment, but in India, it is also a status symbol. Today, the price of this shiny metal is soaring high. As on 31^st July 2020, the price of 995K gold (24 carat)  was around Rs. 5300 per gram. On 1^st January 2020, it was around Rs. 3900.

 

In this article, I shall try to discuss the reasons for rising gold prices and the main avenues of gold investment in India.

 

 Reasons for Increasing Gold Prices

We know that the world is facing a pandemic. There is a significant decrease in economic activity. In April and May 2020 when India was almost under lockdown due to pandemic, the gold demand plunged. The gold imports in India reduced by 99%. As per simple economics, when there is a sharp decrease in demand, the price of that product also decreases. However, that doesn’t look true for gold. The gold prices are still rising. The following are the reasons for the same:

 

      i.          Rising international prices:  Like oil, the prices of gold are highly dependant on the international market.
In the international market, the prices of gold are calculated per Troy ounce (approximately 31 grams). The spot gold price which was USD 1527 per ounce on 2^nd January 2020 has risen to USD 1965 per ounce on 31^st July 2020.
This is because in the current economic scenario the investors consider gold as a safe haven investment.
Moreover, though the demand in the biggest gold demanding countries, India and China has reduced but the demand for the same has increased in the western countries. Till now, in 2020, about 700 metric tonnes of gold has been added in the vaults in New York, the most since 1993.
This has not only covered up for the lost demand for gold but is pushing the price to an all-time high.

 

    ii.          Surge in demand from ETFs (Exchange Traded Funds): As gold is being considered a safe-haven, demand from ETFs has increased. According to Bloomberg, demand from ETFs has risen by more than 600 tons in 2020 till now. This has crossed retail demand by India and China for the first time since 2009.
This shows that in 2020, the demand is mainly because of investment purposes.

 

  iii.          Weak US Dollar: US Dollar is around two-year low due to the ongoing pandemic and the US-China tensions. Moreover, President Trump suggested a delay in the US elections.
A weaker dollar means more gold can be purchased in terms of other currencies leading to increased demand and thus higher price.

 

Gold Exchange Traded Funds (ETFs)

An ETF is a security that tracks the performance of an index, commodity or a basket of assets. The units of this fund are freely traded on the exchange like stocks.
Gold ETF is a type of physically-backed commodity ETF. It means that the fund is in possession of the commodity. (Gold in this case).
Gold ETFs primarily invest in physical gold and also in gold mining companies. The units can be bought and sold on the exchange. Their price is based on gold prices.
Since Gold ETFs possess gold against every unit sold, therefore more investment in the ETF means more demand for gold by the ETF. Now you can relate the 600 tonnes of gold demand by the ETF. Higher the demand for gold, higher the price.
Following are the characteristics of Gold ETF:

a)  Investment: In India, Gold ETF units can be purchased starting from 1 gram to a maximum of 4 Kg. SIP (Systematic Investment Plan) mode can also be used for investing in the ETF instead of investing in lump-sum.

b)  Demat form: It is held in Demat form. Moreover, since it is held electronically there is no risk of lack of purity of gold. Gold ETF units are of 99.5% pure gold.

c)   Lock-in period: It has no lock-in period. It can be traded like a share.

d)  Charges: Brokerage charges of approximately 0.5% on every transaction and Fund Management Charges (maintenance) of 1% p.a. Therefore, return on Gold ETF net of charges is less than that of physical gold. But then physical gold involves the risk of theft.

e)  Taxation: It is subject to Capital Gain only on redemption. If the period from the date of investment to redemption is less than 36 months, it is subject to Short Term Capital Gain (STCG). If the period is more than 36 months, then they are subject to Long Term Capital Gain (LTCG) at 20% after indexation or 10% without indexation (whichever is lower).

f)     Liquidity: Though these are freely tradable on the exchange like a share but their liquidity is moderate due to lack of awareness of this product.

 

 How are Prices of Gold Determined in India

In India, there is no formal authority that sets the price of gold. An informal association named Indian Bullion and Jewellers Association (IBJA) plays a key role in deciding the spot price. It is a group of top jewellers. These jewellers give their buy and sell price and the IBJA takes an average of these buy and sell price and after including the taxes, the price for the day is decided.
The futures price of gold decided by National Commodities and Derivatives Exchange (NCDEX) and Multi Commodity Exchange (MCX) also plays a role in deciding the price of gold.
In India, gold is nearly imported. Let us understand the broad steps, how the gold price is fixed in India taking the example of gold import from London:

 

a)            The London Bullion Market Association determines the spot price of 24-carat gold.

b)            A transactional charge of about 0.2% is added by the exporting bank to the retail price. This gives the Metal value in US Dollar per Troy Ounce.

c)             This is converted to value per 10 grams in INR as per the exchange rate. (For example, if the metal value comes to $1950 per Troy Ounce then it will be approximately Rs. 47000 per 10 grams at the rate of Rs. 75 per USD.)

d)            To get the Landed price, import duty (12.5% as of now) and 3% GST are added.

e)            It is based on this price that the Indian spot price is calculated as per government policies and demand & supply trends.

f)               Based on spot price that jewellers levy making charges(labour cost, alloy wastage charges and business overheads) to arrive at the final price for the customer. Currently, making charges are subject to 5% GST.

 

 Other Avenues of Gold Investment in India

Though we purchase jewellery, that is for our own consumption, it cannot be considered as an investment. The main reasons for avoiding jewellery as a form of investment are:

1.   lesser returns due to deduction in the form of making charges

2.   risk of theft or storage cost in the form of locker rent

3.   risk of impurity

4.   lack of income, as such jewellery is not used for investment.

 

Apart from Gold ETF (discussed above)  following are the other options to invest in gold.

 

a)  Physical gold: Gold can be purchased physically in the form of bullion (i.e. gold bars and biscuits) or coins. There is no chance of impurity as bullion is in the form of 24-carat gold. Though as mentioned earlier, physical gold also has storage cost or storage risk.
Physical gold is subject to 3% GST

 

b)  Digital Gold: Gold can now be purchased in electronic form through digital wallet platforms and other such apps. These apps (known as partner platforms) collect money from buyers and purchase electronic gold form in the buyer’s name from authorised companies. These companies remain the custodian of digital gold that is stored in their vaults right from the purchase by the buyer till redemption. It can be bought and sold 24/7. Buyer can also take delivery as physical gold.
In India, the following companies sell digital gold:

MMTC-PAMP: A public-private partnership between Metals and Minerals Trading Corporation and PAMP: a Swiss company; and two private companies: Safe Gold and Augmont.
Digital gold is subject to 3% GST.

 

c)  Gold Mutual Funds (Gold MF): In case the investor doesn’t have a Demat account then investment in ETF is not possible. In that case, the investment can be made in Gold mutual funds. These mutual funds generally invest in Gold ETFs.

 

d)  Sovereign Gold Bonds (SGB): These are issued by RBI from time to time. Currently, Series V (2020-21) issue is going on between 3^rd to 7^th August 2020 at the price of Rs. 5534 per gram (Rs.50 less if paid online). They can be traded on the exchange.
SGB earns an interest of 2.5% p.a.

 

Let’s compare  important points of the above options and Gold ETF

 

	Physical Gold	Digital Gold	Gold MF	SGB	Gold ETF
SIP	No	Yes	Yes	Yes	No
Liquidity	High	High	High	Moderate	Moderate
Minimum Investment	0.25 gram (assumed)	Re. 1 (theoretically) SafeGold: Rs. 10	Rs. 500	1 Gram. Max 4 Kg	1 Gram Max 4 Kg
Delivery	Yes	Min. 0.5 -1 Gram	No	No	Min. 1 Kg (not all ETFs)
Loan	Only coins up to 50 gram	No	No	Yes	No
How to Buy	Dealers, Banks	Digital Platforms	MF Apps, Banks	Banks, Post Office, SHCIL	Stock Brokers
Tenor	-	Up to 5 years after which the holding has to be redeemed or delivery should be taken as charges levied for extension.	-	8 Years. Exit option in 5th 6th and 7th Year.	-
Taxation	On Redemption. STCG up to 3 years LTCG beyond 3 years holding period	On Redemption. STCG up to 3 years LTCG beyond 3 years holding period	On Redemption. STCG up to 3 years LTCG beyond 3 years holding period	LTCG exempt if held till maturity. Interest taxable.	On Redemption. STCG up to 3 years LTCG beyond 3 years holding period

 

 

 Gold in the investment portfolio

The biggest reason one should consider including gold in the portfolio is that it acts like a hedge against inflation and other investment losses. For example, one has invested in stocks, the risk of loss in stocks is very high, we have seen how the stock market has behaved in the recent past with the ongoing pandemic and even in the past during 2008 financial crisis. It has been really unstable. Gold also witnesses a fall but the fall is generally not steep and not so frequent. It is much stable as compared to equity. That’s why it is considered a safe haven investment as mentioned earlier in the article.
Still, one should not go overboard on gold as an investment asset class. The investment should not be more than 5 -10 per cent of the portfolio.
Now, the question arises, is this the right time to invest in gold?

We need to understand that if we invest in gold now, when it is at record high levels, the growth will be less. It is said that gold has a trend of staying flat for around seven years. So, those who purchase gold now will do it at a higher rate and when they sell it, it will be more or less flat. Whereas in the same time stock market would have moved upwards. If one invests money in the stock market after selling gold then the desired returns are not achieved. Hence, in the current situation, if one is planning to invest in gold, it should be aimed at a longer time horizon.

 

 

Recent Developments

 

International Bullion Exchange: In the 2020 budget speech, the Finance Minister (Govt of India) announced setting up of International Bullion Exchange at GIFT City IFSC near Gandhinagar. (Read my article on IFSC Here)

The derivatives trading in precious metals (Futures and Options) is offered by India INX International Exchange.

 

Amnesty scheme for illicit stash of gold: The Ministry of Finance is planning to introduce an amnesty scheme for Indian citizens possessing unaccounted gold. The aim is to stop tax evasion and bring the illegally possessed gold to book by charging it to tax and penalties.
The people who declare their hoarding will have to deposit their gold with the government for a few years.
The objective is to tap the world’s largest unaccounted stash of gold. It is said that India has about 24,000-25,000 tonnes of privately held gold. Whereas, RBI’s gold reserve is mere 653 tonnes. One can imagine the positive effect on the Indian economy even if a part of the unaccounted gold is brought into the system. It will heavily reduce our dependence on imports of gold.
Though it has to be seen how far the government can implement this scheme as the Supreme Court has ruled earlier that citizens cannot claim absolute amnesty as it puts honest taxpayers at a disadvantage.

 

 

Conclusion

The gold price fluctuates daily but it is still a stable asset class. We need to understand that Gold is not just to be consumed personally in the form of jewellery but it has positive characteristics that also make it a good candidate in the investment portfolio.

 

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