We are in the middle of the festive season and this time of the year, as per Indian cultural tradition, is auspicious for buying Gold. India is the largest importer of Gold in the world, around 900 tons every year; primary end use of Gold import is in the jewelry industry. Gold import jumped 4% on a year on year basis in the first half of this fiscal year (April to September 2018). This is despite Rupee depreciation which has increased the cost of Gold. Gold import may rise further in the second half of the year due to the festive and wedding season. Another factor which may contribute to increase in Gold demand is weakness in equity markets in India; Gold is seen by many investors as a safe asset class.
Economic Utility of Gold for investors
The chart below shows the long term annualized (CAGR) returns of 24 Carat Gold over various time-scales. You can see that over long investment tenors, Gold is a hedge against inflation. Gold, as an asset class, is also much less volatile than equity – the perceived safety of Gold appeals to many risk-averse investors. Finally, historical data shows that gold price trajectory has negative correlation with equity. Therefore, from an asset allocation perspective, Gold adds balance to a diversified portfolio of assets compromising of equity, debt, gold and other asset classes.
Demand for Gold in Indian culture
The economic utility of Gold aside, Indians have a tremendous cultural affinity for Gold. As per Hindu cultural and religious traditions, Gold is bought on auspicious occasions like AkshayaTritiya, Dhanteras, Diwali etc. The most important use of Gold for Indian households is in weddings as gifts to the bride and groom in the form of jewellery. Gold jewellery, as per our cultural traditions, also forms family heirlooms to be handed down from one generation to the next. It forms a major part of the estate (inheritance) left behind by parents for their children and grandchildren. Gold forms an important part of our culture and household assets. That is why, despite numerous initiatives of the Government, including legislations enacted in the Parliament to curb Gold imports which are a drain on our foreign exchange reserve and weakens our currency, demand for Gold has increased over time.
How do we usually buy Gold and its disadvantages?
- The most popular mode of buying Gold is from jewelers, in the form of Gold jewellery. Buying Gold in the form of jewellery has fourmajor disadvantages strictly from a financial standpoint.
- Gold jewellery involves making charges (for the craftsmanship). Making charges can add as much as 15 – 20% to the cost of the Gold used for making the jewelry. Add to it Goods and Services Tax (GST) for the jewellery and your cost is even higher. If you intend to gift Gold jewelry to your daughter or daughter-in-law twenty years later during their wedding and the old design goes out of fashion, you will have to incur the making charges and taxes again in order to remake the jewellery as per current fashion trends.
- Pure 24 carat Gold is not suitable for making jewellery because it is too soft. Gold jewellery invariably has impurities (can be 10% or more). If you want to sell Gold jewellery or remake it, the impurities will be deducted from the value of the Gold. You will have to bear the financial cost of impurities if you have to monetize or remake gold jewellery.
- Unless you buy hallmark gold, there is no guarantee of purity or fair price when you sell gold or melt the gold for remaking a piece of jewellery. Not all jewelers in India sell hallmark gold jewelry. Many families are shocked when a new jeweler deducts a big amount on account on impurities for non-hallmark gold jewellery sold by another jeweler. You have to take this factor into account when buying gold jewellery.
- You need to take proper precautions to store gold to mitigate security concerns. You may have to invest in security systems and locker to store Gold jewellery. Alternatively, you may store Gold in bank lockers, but it has a cost associated with it.
- The other mode of buying Gold is in the form of pure Gold bars and coins. Buying pure Gold bars and coins mitigates the issues related to making charges and impurities, but you will have to incur storage costs.
Best way of investing in Gold
Gold exchange-traded fund (or Gold ETF) is an exchange-traded fund (ETF) that aims to closely track the price of gold. Gold ETFs are units representing physical gold which may be in paper or dematerialized (digital) form. The units of the gold ETFs are traded on the stock exchange just like shares of a company. There are a number of gold ETFs listed on the stock exchanges. To buy and sell gold ETFs on the stock exchange you need to have demat and trading account. If you have demat and trading account for share trading or mutual funds you can use it to buy gold ETFs.
You have to pay brokerage fees & demat charges to buy and sell ETFs. Investors should note that unlike buying or selling stocks, no Securities Transaction Tax (STT) is levied on buying or selling ETFs. But you will have to pay 0.5 - 1% as recurring expenses for the ETF. However, if you compare these costs with making charges, cost of impurities and storage charges, Gold ETFs is a much cheaper and safer way of investing in gold.
Saving for your children’s wedding through Gold ETFs
Gold ETFs, in our view, is a much better way of saving for your children’s wedding. Instead of incurring making charges and cost of impurities when making Gold jewelry, simply invest in Gold ETFs, which is equivalent to buying pure Gold. The costs you save when you invest in Gold ETFs will enable you to buy more Gold or use it for other financial goals like your children’s education or your own retirement planning. Costs saved when invested wisely over a long investment horizon, yields substantial financial benefits through the power of compounding. You can buy Gold ETFs systematically or tactically, online or through your broker; saves you the time and effort to visit your jeweler.
Further, when you buy Gold ETFs, you do need to rent a bank locker to store the Gold and you can save recurring costs associated with the same. The AMC ensures safe custody of your Gold value at a very low cost. The custodian provides guarantee by holding pure 24 carat physical Gold to meet redemption request at any point of time.
At the time, of your children’s wedding, simply redeem your ETF units; your redemption proceeds will be equal to the value of pure 24 carat physical gold at current rates. You can use the redemption proceeds of the Gold ETF to buy Gold jewelry for your children, as per current fashion trends or your children’s personal preferences. If you want to gift Gold which may not be for immediate end use by your children, you can also gift them the Gold ETF which they can later use as and when they choose to. Gold ETF is the best way to gift your children happiness and freedom of choice.
Taxation of Gold ETFs
For both physical Gold (jewelry, bars and coins) and Gold ETFs, the minimum holding period for applicability of long term capital gains is 3 years. For investment periods of less than three years, profits from sale of Gold (ETF or physical) will be added to your income and taxed as per your income tax rate.
For investment periods of more than 3 years, long term capital gains tax applies. Long term capital gains in Gold ETFs and physical Gold is taxed at 20% after allowing for indexation benefits. Prior to 2014, Gold ETFs enjoyed a significant tax advantage over physical Gold, but even after the tax advantage was taken away by the NDA Government, Gold ETFs offer significant financial benefits compared to physical Gold, as discussed in this post. A significant tax reform enacted by the NDA Government with regards to Gold as an asset class was the abolition of Wealth Tax on Gold above a certain asset value.
On Gold jewellery, however, even if there is no wealth tax and no restriction on holdings, as per CBDT circular in December 2016 (after demonetization), you may be subject to Income Tax enquiry or even seizures, if the weight of your gold jewelry exceeds a certain weight (as prescribed by the circular, e.g. 500 grams for married ladies, 250 grams for unmarried ladies 100 grams for men).
In case your jewellery exceeds the prescribed limits in terms of weight, you may have to produce the invoice of the jeweler and explain the source of the investment. If the Income Tax officer is not satisfied with your explanation and feels your gold assets are disproportionate to your income then the officer may confiscate your jewellery. Transactions (purchase or sale) related to Gold ETFs, on the other hand, are done through banking channels and there is documented trail for all transactions. Therefore, you are saved from the hassles discussed above if you purchase Gold ETFs.
Gold is an auspicious investment for many Indian families. Gold ETF is the cheapest and safest way of purchasing Gold. You can invest in Gold ETFs for gifting to your children / grand-children or other loved ones during weddings and other auspicious occasions. From an economic viewpoint, Gold is an useful asset class to balance your portfolio asset allocation. You should consult with your financial advisors about Gold ETFs and make it a part of your financial planning.
Mutual Fund Investments are subject to market risk, read all scheme related documents carefully.