Home >Money >Personal Finance >Gold ETFs trading at a premium to NAVs - should you buy?

Gold has emerged as one of the best performing asset classes for investors. It has delivered a return of 11% (in rupees terms), according to data from the World Gold Council data as on 9 April, compared to a correction of over 25% in equities as on 13 April 2020. No wonder the investment demand for gold has gone up substantially.

“Precious metals such as gold have always been viewed as a safe asset class and are chased by investors in times of uncertainty or market turmoil. The recent surge in prices is more driven by macroeconomic concerns due to the covid-19 or novel coronavirus crisis," said Ankur Maheshwari, CEO, Equirus Wealth Management.

One of the efficient ways of buying the yellow metal is through gold exchange-traded funds (ETFs), which also seem to be in high demand. Assets of gold ETFs have gone up by 34% from 5,767 crore in December 2019 to 7,949 crore in March 2020, according to data from the Association of Mutual Funds in India (Amfi). In fact, gold ETFs are trading at a huge premium to their net asset value (NAV). For instance, the SBI Gold ETF closed at a premium of 9% to its NAV on 13 April 2020, while Aditya Birla Sun life Gold ETF and Kotak Gold ETF closed at a premium of over 7% each.

Gold ETFs invest in physical gold with each unit of the ETF typically representing 1 gram of gold. To understand why gold ETFs are trading at a premium to their NAVs, we first need to understand how gold ETFs are priced.

Two prices

Gold ETFs have two types of prices—one is at which it trades on the exchange and the other is NAV based on the valuation of gold, as per the market regulator’s guidelines.

“Gold ETFs are valued based on the prices published by the London Bullion Market Association (LBMA). The daily LBMA AM (they publish both AM and PM) prices are taken by the fund houses and converted into rupee terms after adjusting for customs duty and other costs such as goods and services tax (GST) to arrive at the NAV," said Vishal Jain, head, ETF and fund manager, Nippon India Mutual Fund.

The NAV price is also known as the landed price of gold. It can be different from the domestic trading price of physical gold in the wholesale market. The traded price of gold ETFs is expected to be in line with the wholesale domestic price of gold, though demand also has a bearing on it. “The traded price of gold ETF is generally in line with the domestic physical gold price but due to the demand factors, it might trade at a premium or discount to domestic physical gold prices in India. In recent times, as the demand for gold investments has gone up, we are seeing some of the gold ETFs trading at a premium to physical gold prices," said Chirag Mehta, senior fund manager, alternative investments, Quantum Mutual Fund.

“Right now, even the domestic gold prices in the wholesale market are at a premium to the landed price of gold on which NAV is calculated," he added.

Lockdown premium

The premium on the prices of domestic physical gold has gone up further given the supply disruption due to the lockdown. Exports have stopped and so has domestic movement of gold. “The premium on gold ETFs over their NAV has also gone up due to the lockdown which has restricted the movement of physical gold and hence the supply has disrupted," said Lakshmi Iyer, CIO (debt) and head of products, Kotak Mahindra Asset Management Co.

Recently, SBI Mutual Fund stopped taking lump sum investments as well as systematic investment plans (SIPs) and systematic transfer plans (STPs) in its gold fund, citing closure of vaults during the lockdown as the reason.

With the lockdown being extended till 3 May, experts believe that the premium may go up further. “The current premium in domestic gold prices are abnormal which is also reflected in gold ETFs’ traded prices. Increased demand for gold ETFs is further pushing up the premiums. We have seen gold ETFs trading at a premium or discount of up to 3% to the NAV over last one year," said Mehta.

If the demand continues to surge, the current inventory will go down, in turn pushing up premiums further. “However, after the lockdown gets over, the premium may go down as more supply comes in," he added.

During normal times, market makers (bullion traders), also known as authorised participants (APs), try to use the arbitrage between the prices of ETFs and domestic physical gold by buying or selling units of the ETF directly to the fund house at the NAV. APs can transact with the fund house in the form of cash or gold. So, if the gold ETF is trading at a premium to the NAV, the AP can buy the units directly from the fund house at the NAV and sell them on the exchange, bringing down the traded price closer to the NAV. “Right now APs are doing limited arbitrage because of the limited resources due to the lockdown," said Iyer.

Gold funds shine too

Even returns from gold funds, which invest in gold ETFs, have shot up. The returns from gold funds are calculated on the basis of the traded price of the underlying ETF, while the returns from gold ETFs are calculated based on the NAV. SBI Gold fund delivered a one-year return of 64% as on 13 April 2020, the highest in the category, while Kotak Gold has delivered a return of 54%, the next best number.

Should you buy?

Gold is a good asset class for diversification and one should have an allocation of 10-15% to the yellow metal to support the portfolio during turbulent times as we are witnessing right now. However, buying gold ETF at such high premium may not make sense as it is due to the short-term supply disruption may go away as things normalize.

“I would advise investors not to rush to buy gold ETFs at such a high premium and would recommend them to invest in a staggered manner," said Kartik Jhaveri, founder and director, Transcend Consulting Ltd, a financial services company.

While investing in gold ETFs, you should look at the tracking errors of the underlying ETFs. Tracking error is the difference between the returns of gold ETFs and physical gold, which is the benchmark in this case. Liquidity is another factor to look at.

“For ETFs, it’s also important to look at the bid (price that buyers are willing to pay) and ask (the price sellers are willing to pay) spreads (difference in these two prices) and the trading volumes so that investors can buy at a reasonable price," said Kavitha Krishnan, senior analyst manager, research at Morningstar India. Investors should look for a tighter spread, where the difference between the bid and ask prices is low, and higher trading volumes.

Also, some experts believe that sovereign gold bonds are a better option than gold ETFs. “If someone is looking for long-term investment in gold, then I would recommend SGBs as they are not only tax efficient but also provide an assured 2.5% fixed interest (over and above the returns from gold," said Suresh Sadagopan, founder, Ladder7 Financial Advisories. The government has announced the dates for the issuance of gold bonds. There will be six issues starting April to September.

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