How about some gold for the volatile times?

The love for gold in India is legendary. Besides bank fixed deposits (FD), it has historically been one of the most preferred ways of investing money. This is especially true of the rural areas, where even the penetration of banks is low. So there has always been a good demand for gold in India.

Factors such as:
(a) The volatility in the equity markets worldwide,
(b) Concerns of the United States recession,
(c) Inflationary pressures due to high oil, commodities and food prices and
(d) Weakening dollar -- have generated a lot of interest in gold amongst the investors worldwide. So we have seen the prices of gold more than double from around Rs 6,000 in early 2006 to more than Rs 12,000 recently.

Traditionally, the only option available to buy gold was in the physical form. But with the launch of Gold Mutual Funds (ie, the Gold Exchange Traded Funds - ETF), you can now buy gold in the demat form. If you were interested in buying gold, you would need to broadly answer two questions:
(a) Should I invest in gold and
(b) If yes, then which is better – physical gold or gold ETF?

Since the answer to the second question is simpler, let’s look at that.

Physical gold or Gold ETF?
In case gold is being bought purely for investment purposes, then Gold ETF scores over physical gold.
1. Low cost: When you buy Gold ETF you have to pay only the brokerage charges, which is usually around 0.5%. Vis-à-vis, you may have to shell out between 10 and 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 you pay the annual fund management charges of 0.5-1%.

2. 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.

3. Purity: You need not be concerned about the purity of gold in Gold ETF.

4. Security: No one can steal your Gold ETF units.

5. Capital Tax Gains: In case of physical gold, the long term capital gain tax becomes applicable only when the holding period exceeds 3 years. This limit is just 1 year in case of Gold ETFs.

6. Wealth Tax: Physical gold attracts wealth tax whereas Gold ETF is exempt from wealth tax.

7. 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.

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.

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 you 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 you were to look at ‘annual returns’ over the last 2 decades, you will find the returns to look like this:
Years Returns
First 3 years -2 to -17% (negative)
Following 11 years 1 - 7%
Following 3 years 11 - 17%
Following 3 years 26 - 33%

So, if the past trend continues, you can 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.

It could be said that you may invest a small portion of your corpus in gold as a means of portfolio diversification. But you should not expect high returns, especially the kind of returns you might have seen in the recent past. Equities and real estate would still be a better bet for wealth creation.