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Business News/ Money / Calculators/  Comparing paper gold: bonds versus ETFs
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Comparing paper gold: bonds versus ETFs

The proposed interest payout works for gold bonds. But there is a large enough market for both products

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As a potential solution for reducing India’s expanding gold import bill, finance minister Arun Jaitley had proposed the introduction of gold bonds as an alternative to investment in physical gold, along with a gold monetization scheme in which investors can deposit their gold in banks and earn interest on it.

Indians have a special love for gold. But there is demand and supply mis-match and the fallout of this is high gold import levels, which affects trade deficit. Even though Indians bought lesser gold in 2014 than in 2013, India remains at the top when it comes to global demand for gold. According to data from the World Gold Council (WGC), in 2014, the total gold demand from India was 842.7 tonnes—the highest globally, even if it was 13.5% lower than in 2013.

Investment demand, too, fell—from 37% of total demand in 2013 to 21% in 2014, mostly due to lower prices, which made the investment unappealing. Yet, in 2014, the overall gold investment demand in India stood at around 180.6 tonnes, WGC data revealed. As prices stabilize, this figure isn’t expected to fall much this year.

Meanwhile, a draft outline of the Sovereign Gold Bond Scheme has been released (https://mintne.ws/1IZxGUk) , and elaborates on proposed features (See chart). But before you decide to buy gold bonds, let’s compare these with gold exchange-traded funds (ETFs).

Paper gold

A product that tracks the returns of investing in gold, but without the inventory pile-up and quality check worries, is a welcome innovation. Given its features, the gold bond is expected to mirror the dynamics of investing in physical gold.

But this isn’t the first such product; gold ETFs have been around since 2007, and are an efficient option to get gold-like returns in an electronic format. Gold ETFs are mutual fund units, which give investors the opportunity to get returns in line with the change in gold prices but without having to own the metal. Each unit is backed by 24-carat gold of 99.5% purity.

Lately, falling prices of gold have meant a fall in demand for it. The total assets under management for domestic gold ETFs was 6,688 crore as on May 2015, down from a peak of around 12,000 crore in January 2013. Globally, too, the investment demand for gold has declined in 2014 from that in 2013. ETFs worldwide are witnessing redemptions.

Shift in demand

Gold bonds and ETFs both track gold price. But the interest payout on gold bonds—which is proposed to be linked to international rate of gold borrowing, or at least 2%—can render them more attractive. In contrast, ETFs only offer returns that track the change in price of gold.

Another major difference lies in expenses. Unlike the bonds, ETFs have an expense or management cost attached. The average annual expense ratio for gold ETFs is around 1.03% of total assets (maximum of 1.07% and minimum of 0.96% among existing funds).

What this means is that when you redeem your bond after, say, 5 years, you will not only be able to capture gains (or losses) on the price of gold within that period, but also earn 2% interest every year (the current draft guidelines have, however, not specified whether the interest will be calculated as simple interest or compounded). In contrast, gold ETFs only return the gains (or losses) on price of gold post-expenses.

On the flip side, the amount you can invest in gold bonds every year is restricted—proposed limit per person per year is 500 gm. There is no such limit for gold ETFs. Moreover, ETFs are accessible and tradable easily on stock exchanges.

Abhishake Mathur, head-investment advisory, ICICI Securities Ltd, said, “It (gold bonds) seems superior to gold ETFs, and the additional interest is likely to have an impact on the demand for gold ETFs. But one has to wait to see the ease of buying and redemption. ETFs are very liquid and have a market making process in place."

Ultimately, there may be a market for both.

“There is excitement around the proposed bonds. While some demand can shift, ETFs and gold bonds may coexist given the varied investor needs," said Lakshmi Iyer, chief investment officer (debt) and head-products, Kotak Mahindra Asset Management Co. Ltd.

Gold ETFs are usually sold by mutual fund distributors, which is likely to continue. These are marketed to high net worth and retail individuals, but mostly in large cities. On the other hand, the gold bonds may be available through post offices and banks, which will help in reaching out to retail investors even in smaller towns and villages.

While gold ETFs are a familiar route, especially for mutual fund investors, gold bonds will be issued on behalf of the government, which may appeal to the more conservative individual. “Whenever you try to turn a real asset into a financial asset , there are always dropouts. Real assets have more emotional and expressive appeal. It is hard to replace that. It will, therefore, take time for investors to accept the change," said Mathur.

Ultimately, the ease of transaction, tradability and liquidity of the gold bonds will have an impact on the investor interest.

“The product being out is a good start, but for distributors there has to be enough incentive to market it," said R. Sivakumar, head-fixed income, Axis Asset Management Co. Ltd.

Mint Money take

Distribution is important. The National Pension System (NPS), for example, is a fundamentally good product but requires suitable distribution. Gold bonds could gain more visibility if jewellers are also roped in, and distributor incentives are well defined.

The Indian penchant for owning the metal means that at times there is no defined distinction in demand for jewellery and investment.

So, simply putting out paper gold may not be enough to shift demand. Easy access for investors and operational ease will be critical for the success of gold bonds.

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Published: 22 Jun 2015, 08:22 PM IST
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