Festive Season? Celebrate with Gold

In a Nutshell

For Long Term Investors buy gold biscuits

For Non Investment Ladies who would never sell buy jewellry.

For Short Term Investors less than one year buy ETF’s

Deep Dive

Why Gold?

There are various reasons for which you should own gold in your portfolio. The most important of these is that gold is a real asset whose value is driven by factors (such as the amount of gold mined) that are very different from those that impact the value of financial assets. Therefore, it brings in a much needed element of diversification in your portfolio

Form of Gold

The next question that is often put to us is in which form should one hold gold? The one form which we all are familiar with of course is jewellery. However, from an investment perspective this is not the best option as the making charges for jewellery can be as high as 30% of the value of the gold i.e. if your jewellery has gold worth Rs 100, you are probably going to be buying it for Rs 130. So if you wish to sell your jewellery, all you will get is the value of the gold; the making charges will be a loss to you. Not to mention that sometimes jewellery that is promised to be made of 22K gold turns out to be of a poorer quality.

The best form to hold gold, from an investment perspective, is probably, gold bars (or like they say “biscuits”!). Gold bars are standardised products whose purity is assured by the hallmark (seal of the producer) that it carries. There are no making charges involved and as the purity and quantity is assured, on liquidation you do not have any surprises in store for you.

The returns from gold:

During the 1950s, gold appreciated only marginally; from Rs 99 per 10 gms in 1950 to Rs 111 per gms in 1960. During the next decade, from 1960-70, it moved up to Rs 184.

Between 1970 and 1980 came the massive rise from Rs 184 to Rs 1,330.

During the 1980s, it moved up another 240 per cent. The trend of gold prices in India in the last few years is given in Table 1 which reveals that between 1950 and 2007 gold appreciated 95-fold, an annual compound rate of return of 8.32 per cent.

Gold prices in India
March end Gold price per 10 gm (Rs) 1925 18 1930 18 1935 30 1940 36 1945 62 1950 99 1955 79 1960 111 1965 71		March end Gold price per 10 gm (Rs) 1970 184 1975 540 1980 1,330 1985 2,130 1990 3,200 1995 4,658 1996 5,713 1997 4,750 1998 4,050		March end Gold price per 10 gm (Rs) 1999 4,220 2000 4,395 2001 4,410 2002 5,030 2003 5,260 2004 6,005 2005 6,165 2006 8,210 2007 9,500 2008 11000

How to buy gold

Gold Deposit Scheme

Introduced in 1999, this scheme is managed by SBI Individuals, HUFs, trusts and companies can deposit a minimum of 200 gm of gold with no upper limit, in exchange for gold bonds carrying a tax-free interest of 3 to 4 per cent depending upon the tenure of the bond ranging from 3 to 7 years.

Furthermore, these bonds are free from wealth tax and capital gains tax. The principal can be collected back in gold or cash at the investor's option

Banks

In recent months, banks have become very aggressive in marketing gold bars. This pick up in tempo is not only due to the festive season; it is also due to the fact that banks have hit upon a new idea to make a “neat buck” off you. We will let the numbers speak for themselves.

On the 8th of November, 2006 we called one private sector bank and one jeweller making an enquiry to purchase gold. This is what we got as a response –

Expensive, for sure

	Bank (Private)	Branded Retailer	Jeweller
Purity	0.999	0.999	0.999
Price per kilo* (Rs)	1,071,520	1,025,000	940,000
% Discount to Pvt Bank Rate	NM	4.5%	14.0%

* Prices as on 8th of November 2006; Including VAT
NM - Not Meaningful

Do not make a judgment as yet. The banks, as their relationship manager will definitely pitch (only if you ask though), give you a certificate assuring you of the purity of the gold. And that’s why they charge a premium for the gold. So, on the one hand you get pure gold with a “certificate” and on the other you get just pure gold.

To be able to make a rational decision, let’s ascertain the value of the certificate i.e. what benefit it offers you. In case of standard gold bought for the purpose of investment, the benefit which one looks for is whether the seller will buy the gold back or not and, if yes, at what price will he buy it back?

Banks lose out

Gold Bar	Bank (Private)	Branded Retailer	Jeweller
Buy back facility	No	Yes	Yes
Discount on buy back	NA	NIL	NIL

Here’s an eye opener for you. The bank, which pushed you into buying standard gold at a premium, will not buy the gold back from you! So, if you bought gold from a bank today for Rs 100, and you needed to sell it the same day (to a jeweller as the Bank will not buy the gold back from you), all your will realise is Rs 86! Of course, you get to keep the certificate!

The jeweller on the other hand, will buy back gold from you any day at the prevailing price. Some jewellers also give you a certificate for the gold you buy, thus diluting a key selling point of the bank.

The answer to the question of where you should buy gold from is simple – give the banks a skip in case you are looking at buying gold. Opt instead for a credible jeweller (even in the case of jewellers, we found that there is a lot of price variation with branded stores charging a premium – do your homework well before you buy gold). And, of course always buy standard hallmarked gold.

If you do decide to go to a jeweller to buy gold in bulk, do negotiate. It is likely you will get a discount. In our conversations with a couple of brokers, we were offered a discount on bulk purchases.

THE NEW ETF ROUTE

The modern international method of investing in gold is via gold mutual funds. India should soon be catching up in this area.

In his Union Budget for 2005-06, Finance Minister P Chidambaram had proposed that Securities and Exchange Board of India should permit mutual funds to introduce Gold Exchange Traded Funds (Gold ETFs) with gold as the underlying asset.

According to the Budget proposals, the scheme would enable households to buy and sell gold in units for as little as Rs 100 and such units could be traded in the same manner as units of mutual funds.

Gold Exchange Traded Funds are a relatively recent phenomenon even in the American market where the first Gold ETF--StreetTracks Gold--made its debut in the New York Stock Exchange in November 2004. Each unit of the StreetTracks Gold ETF represents one-tenth an ounce of gold.

In Gold Exchange Traded Fund, the underlying asset is exclusively gold bullion, and not a basket of stocks as is the case of equity ETFs. Gold ETFs are shares or units of gold that are owned by investors and are fully backed by gold bullion bars held by a custodian.

Like other ETFs, they are traded on a stock exchange.

Gold ETFs will allow investors to buy gold in small increments. In the global market, one unit represents one-tenth of an ounce fine gold (1 oz-28.35 grams). If an investor in the fund holds 100 units, the fund must have physical gold worth 10 ozs.

The value of the unit will move in accordance with the price of gold. Just like mutual funds, the value per unit will be the total value of the gold held, divided by the number of units, minus the expenses of the fund. Gold ETFs, like any share, can be traded and bought by the investors through their stockbrokers.

They can be used for speculating in the short-term for betting on the price of gold, or it can be used for long-term investing. Just like the ETFs, Gold ETFs can be open-ended funds or closed ended funds.However there are some hidden charges like some funds need an underlying DMAT account or entry loads causing an additional expense, thus giving gold biscuits an edge hence Presha Invesntments recommends biscuits for long term and ETF strictly for short term.

Tax implications

Since there is no income as such from holding gold, there is no liability of income tax. But bullion and jewellery are subject to capital gains tax and wealth tax, without any exemptions whatsoever.

While determining the value of gold ornaments for the purpose of wealth tax, making charges should be ignored, unless the ornaments are studded with precious stones. The value of gold contained in the ornaments can be reduced by 15 to 20 per cent because the dealer invariably deducts 15 per cent of the ruling rate of standard gold when ornaments are sold in the open market.