Photo: iStock
Photo: iStock

Why is India’s interest in gold ETFs falling?

Rising equity markets, introduction of interest-giving sovereign gold bonds and following gold prices in the US has led to the metal's price falling in India

With equity markets rising (the S&P BSE Sensex has returned 15% in the last 2 years and 26% so far this year), it’s no wonder that other assets—especially gold—have taken a back seat. According to the Association of Mutual Funds of India (Amfi), equity funds have seen net inflows (more money came in than went out) of Rs1.78 trillion so far in 2017. Compared to this, gold exchange-traded funds (ETFs) have seen a net outflow (more money went out than came in) of Rs587 crore. The past 4 years have seen a surge of money coming into equity funds and money moving out of gold. Why are investors running away from gold? Are gold ETFs all that bad and should you sell your remaining stock of gold ETFs?

A gold ETF invests its entire corpus in physical gold bars. Gold ETFs in India aim to track the price of the metal, passively. So, if gold prices go up, the gold ETF’s net asset value (NAV) goes up, and vice versa. 

The price of gold per 10 grams has fallen by Rs4,358 or 3% from its peak price of Rs32,943 it touched in August 2013. But should you merely chase gold ETFs because you expect gold prices to rise or sell when you see prices fall? Let us understand how and why gold prices move up or down.

Since India imports much of its gold, the Indian gold price tracks the dollar denominated international gold prices closely, as quoted on the London Bullion Market Association (LBMA).

“Since we don’t mine much gold, we import most of it. Hence, the gold prices that we see in India are the derived prices; derived from the US gold price. When India imports gold, the price gets converted to Indian rupees, import duty of 10% plus the goods and service tax of 3% gets added to it, and you get the Indian gold price," said Chirag Mehta, senior fund manager–alternate investments, Quantum Asset Management Co. Ltd. That takes us to the US market and what impacts gold there. Gold prices, by themselves don’t move much. The movements depend on how other assets move.

Unlike the equity markets that move based on how the underlying companies in the benchmark indices perform in terms of sales, profitability and business, gold as an asset doesn’t have any underlying fundamental. “Gold, inherently, doesn’t give you any return, like how a bond gives us an interest or equities give us dividends. Gold is a commodity. You only earn from commodities when their prices go up," said Harshal Barot, analyst, Motilal Oswal Financial Services Ltd. 

Take equities, for instance. When equity markets do well, gold prices are usually subdued. Between 2008 and 2013, when the Sensex returned 2.12% post the global credit crisis, gold prices zoomed and returned 22%.

“At the time, people saw gold as a safe asset and therefore a lot of money shifted to gold," said Ritesh Jain, chief investment officer, BNP Paribas Asset Management (India) Ltd. Another reason why gold prices move is movement in currencies. Before the global currencies came into being, gold was long used as the official currency.

Even today, gold is considered as an alternative to currency. If the US dollar moves up against various global currencies, gold prices drop, and vice versa (see table).

Seen from an Indian context, one of the big reasons why gold prices in India also rose sharply after the Lehman crisis was rupee’s depreciation against the US dollar, apart from falling equity markets and rising gold prices in the US.

A depreciating or falling rupee increases the price of an asset—gold price in India, in this case—as the price gets converted to Indian rupees. That’s one reason why the Indian gold price continued to rise till 2013, despite the US gold prices peaking in 2011. The Rupee depreciated by 19%, in the interim, on a compounded basis. All this started to reverse when the equity markets all over the world started to rally.

Besides, the Indian rupee hasn’t depreciated much in the last 3 years and that is also why gold prices in India haven’t gone up much lately. 

Another reason for the decreasing attraction of gold ETFs in India is the introduction of sovereign gold bonds (SGBs) by the government. Budget 2015 had introduced a sovereign gold bond scheme with the aim to encourage people to buy more of electronic or paper gold instead of buying gold in the physical form. These sovereign gold bonds are instruments that can be bought in demat form and come with an 8-year lock-in.

SGBs are listed on the stock exchanges, in case you wish to redeem prematurely. The minimum investment was kept at 2 gram (reduced to 1 gram in the subsequent issue), with a maximum limit of subscription of 500 gram per person per fiscal year (April-March). But where it scored over gold ETFs was that it gave an interest rate (2.75% per annum initially, and 2.5% subsequently). An ETF, on the other hand, charges an annual expense ratio of usually 0.9-1.1% per annum. This reduces your returns. 

“The only problem with SGBs is illiquidity. There is hardly any liquidity on the stock market because in India, the culture of people investing in paper gold is yet to pick up. Indians, traditionally, have an affinity to buying physical gold," said Barot.

As a result, most of the SGB tranches have been trading at discount on the markets.

Should you buy gold as a hedge or investment? Joydeep Sen, founder, wiseinvestor.in, says “both".

“It depends on your investment objective. If you are a jeweller importing gold, this may be used for hedging, apart from the exchange-traded gold contracts. If you are an investor with a bullish view on gold, this is a return instrument. From a different perspective, if you are saving for your child’s marriage, this is a hedge against gold price rise over a long horizon,"  he added.

Mehta suggests that gold can be used as hedge against portfolio volatility. This, he said, enhances portfolio returns. In a study that Quantum AMC did in 2016, it measured portfolio returns (between 1999 and 2015) and volatility with portfolios with 100% equity and nil in gold, 95% equity-5% gold, 90% equity-10% gold and so on till 30% in gold. The study showed that while there wasn’t much difference in terms of returns, the portfolio volatility came down significantly as the portions in gold increased.

Financial planners suggest putting not more than 5-10% of your portfolio in gold.

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