Gold ETFs are the exchange traded funds which have an objective to provide returns as per the price of physical gold. However, many times it happens that Gold ETFs tend to outperform and give higher returns than physical gold.
While buying a Gold ETF, you do not have to pay a premium for making charges. You do not have to worry about its theft and moreover, buying and selling of Gold ETF is much easier than buying and selling of physical gold. Investors who are not aware of gold ETFs need to understand the benefits of gold ETFs over pure gold.
“One needs to consider the additional cost, for example storage cost, while buying physical gold from an investment perspective. Investors in India typically purchase gold in physical form, which along with real estate forms a big portion of the country’s household savings. This savings dynamic is now changing where investors are also considering options such as gold exchange traded funds, gold fund of funds and sovereign gold bonds other than physical gold,” says Dhaval Kapadia, Director, Portfolio strategist, Morningstar Investment Adviser (I) Pvt. Ltd.
Investment in gold as an asset class mainly acts as a hedge against geopolitical uncertainty, inflation hedge or store of value, and provides benefit in case of rupee depreciation. Gold is also considered as a safe instrument where demand for it increases merely when the market participants are in a risk-off mode, while it decreases when they are in a risk-on mode (as per the market volatility). Currently, gold has seen increased demand as its safe-haven appeal rose on the back of an increase in geopolitical risk, mainly related to US airstrikes, elections in France and Germany, and ongoing tensions with North Korea.
“Domestic gold prices majorly track international gold prices. In the past trend, international gold prices have generally shared an inverse relation with the US dollar and US Federal Reserve fund rate. If interest rates move up, it is not a good idea to hold gold since it doesn’t generate any income unlike debt instruments and vice-versa,” says Kapadia.
Allocation to gold should be strategic in nature, i.e. it should be around 5-10% of your total portfolio. Although historically gold shared negative correlation with equities, but ultimately it will provide diversification benefit. From an investment perspective, Gold ETFs can be preferred to physical gold.
The most important fact is that the underlying asset of all the Gold ETFs is gold having a purity of 99.5 percent, which equalizes the performance of most of the ETFs in quite a similar manner. The difference in their performance can be seen only because of the tracking error, which is calculated as the difference between ETF’s returns, gold’s returns, and the expense ratio.
“Gold ETFs can be easily held in a dematerialized form. This, in turn, helps in saving on the storage cost and also avoid security risk. Being listed on an exchange, their pricing is transparent and their purity is guaranteed by the asset management company,” says Kapadia.