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Prologue: Gold, as an investment class, seems to have lost its sheen among the investors mind in the recent
periods given the significant correction seen in the prices of gold. In the last one year period ended on Dec 31,
2013, Gold in INR terms lost 14.74% (MCX Gold Spot Price) while in USD term lost 27.33%.
Considering the Gold ETF, the AUM of the category declined by 27% YoY and stood at Rs. 8,784 crore (as of Dec
2013). The category saw net outflows in 10 out of 12 months in the last one year period of Rs. 1,816 crore.
Globally, gold witnessed its tough phase in 2013, suffering the biggest annual loss in the last three decades on the
back of US Fed tapering concerns, strengthening dollar, high interest rates, bullishness in the stock market and huge
selling by Gold ETF. In the domestic front, the gold in INR term posted loss lesser than the USD term all thanks to
the sharp depreciation in the rupee value and growing demand despite the regularity restrictions.
Outlook: Going forward, the prices of the gold is likely to move slightly upward in the short term in the domestic
front given the growing demand for gold bars and jewelry in Asia especially in China and India. Apart from seasonal
demand, further depreciation in the rupee value (offset by any regulatory relaxation import duty cut from the
current 10% - encouraged by improving trade deficit domestically) will support the prices of the gold to some
extent. A pick-up in central bank buying of Gold may also contribute to a positive trend in demand.
However, stronger global economy, strong dollar, a continued tapering in the Federal Reserves bond buying, rising
US real interest rates, declines in US equity risk premium, no sign of inflation and lack of buyers interest would
impact the appeal for gold globally. Further, a positive Chinese GDP growth forecast, recovery in Europe, and an
above average risk of supply disruptions would be destructive factors for the gold. Above all, ETF and Hedge funds,
the main driving force behind the prices of gold, seem to have turned bearish as Gold ETFs holdings are now at
lowest level since 2008.
While global uncertainty and jewellery demand could keep demand for gold steady in India going forward, any cut
in import duty, relaxations in import of gold or appreciation in INR vs the USD could narrow the difference in gold
prices in India and abroad that has widened to almost 21% currently (partly impact of import duty and partly gold
physical premium due to import restrictions). Hence in the eventuality of any or all of the above happening, gold
prices in India could remain steady or fall even though gold prices abroad rise or remain steady.
Top performing Gold ETF and Gold FoF:
Note: Trailing Returns (%) up to 1 year are absolute and over 1 year are CAGR.
Gold market in India: India is the world's biggest gold consumer followed by China and US. Indian Households hold
more than 20,000 tonnes of gold according to WGC, that is the largest amount of bullion holdings in the world.
Jewellery and investment are the key areas of Indian gold demand. Indias total gold demand was at 864 tonnes in
2012 which was 12% YoY decline compared to previous year. Higher import duties and import restriction impacted
the gold market in India significantly in the year 2013. Despite the sharp depreciation in the Rupee value against
the Dollar, ban on import of gold coin, 80:20 rule and other import restrictions pulled down the gold demand
significantly. On the other hand, gold that entered unofficially into the country together with recycled gold helped
to meet the pent-up demand in the country. Jewellery demand in India dropped 23% year on year on Q3 of 2013
on the back of import restrictions. Demand for gold Jewellery remains strong however, reduced supply has
prevented the demand to be fully realized.
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Source: Gold.org
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The above table portrays the relative performance of Gold and Nifty investments in different investment
timeframes and different investment mode (lumpsum vs SIP). It is worth noting that the return from
investments in gold whether SIP or lumpsum, managed to outperform in the long run returns from Nifty
investments from both modes. However, the gold saw underperformance during in the short term periods like
two and five years periods due to the significant correction in the prices of gold in the recent periods.
Lumpsum returns are better if large sums are invested at periods of market bottoms.
SIP returns are better if it is started at or just after the market tops. Further, SIP route helps out to average out
the cost of the investment.
To conclude, it is advisable to allocate at least 5% in gold of anyones total portfolio for purpose of hedging. The
investor may invest either in lumpsum or through SIP.
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Gold Background:
Gold has been a better performing asset over years among the investment options available in the world.
Despite the mediocre performance posted in the short term, Gold has consistently outperformed other
traditional asset classes such as equity, debt, currencies and other commodities irrespective of most of market
and economic cycles with a compounded annual growth rate of 14.5% in USD term and 17.1% in INR term for
the last ten year period. In other words, Golds value increased nearly 4 times over between 2003 and 2013,
rising from $363.3 to $1,411.2(as of Dec 31, 2013).
Given its special status of universally accepted medium-of-exchange, gold has been used as the standard for
many currencies in history.
Gold is a foundation asset within any long term savings or investment portfolio. For centuries, particularly
during times of financial stress and the resulting 'flight to quality', investors have sought to protect their capital
in assets that offer safer store of value. Gold offers refuge from widespread default risk. It offers investors
insurance against extreme movements in the value of other asset classes.
Gold History:
One of the oldest civilizations, the Sumerians of Mesopotamia, who lived in what is modern-day Iran and Iraq,
first used gold as sacred, ornamental, and decorative instrument in the fifth millennium B.C.
The early Egyptians used gold primarily for personal adornment, rather than for monetary purposes, although
the kings of the fourth to sixth dynasties (c. 2700 - 2270 B.C.) did issue some gold coins.
The first large-scale, private issuance of pure gold coins was under King Croesus (560-546 B.C.), the ruler of
ancient Lydia, modern-day western Turkey. Stamped with his royal emblem of the facing heads of a lion and a
bull, these first known coins eventually became the standard of exchange for worldwide trade and commerce.
Gold is traditionally weighed in Troy Ounces (= 31.1035 grams). It has a specific gravity of 19.3, meaning that it is
19.3 times heavier than water.
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Applications of Gold :
Jewellery: Jewellery is one of the major demand drivers for the yellow metal and the demand comes mainly from
India & China who contribute more than 50% of the world jewellery demand.
Technology: The usage of gold in technology is because of its qualities such as corrosion resistance, good conductor
of electricity, etc. Gold is widely used as connectors & wires in various electronic items as its reliability is high.
Medicine: Golds medicinal importance has been researched many centuries ago & Chinese and Indian people use
gold for medicinal purposes. Gold in recent years has been used extensively in dental applications, due to its
resistance to corrosion and is not harmful when it comes into contact with body.
Nanotechnology: Gold nowadays is used as catalyst and the gold nano particles have been efficient absorbers of
mercury from the water and act as purifiers.
Space & engineering: Gold has many important qualities such as good reflector of heat & infrared radiation. Gold
coating is applied on various items used in space to protect against various radiations that occur.
Weight Equivalents:
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Weakness in other asset classes and lack of safe havens: When the economy and financial markets do not do well,
gold investments can provide a good hedge for any portfolio. Gold is negatively co-related to most of asset classes.
Decline of Mine production and Supply: Gold mining and production have been decreasing in the recent periods
while there is an increase in the demand for gold. An increase in the cost of mining, strikes by gold miners, legal
formalities, geographical problems and worsening political situation have led to a fall in gold mining.
Demand and supply factors: A change in supply could alter the price of gold. If there is a sharp increase in
production, its price is likely to fall. Likewise, the fluctuations in price tend to occur due to changes in demand.
Central bank demand: When dollar value depreciates, central banks of most of the developed countries start to
increase their share of gold in forex reserves.
Changes in exchange rates: Weaker USD usually leads to an increase in world gold prices. It is because investors
choose to sell their dollar and buy gold with the hope that gold can protect the value of their dollar assets.
Geo political and economical concerns: Whenever there is uncertainty prevailing in the globe, the prices of gold
shoot up. In the recent financial crisis the gold prices were in uptrend.
Economic data: The macro economic data such as unemployment data, GDP & Home sales also impact gold prices.
When the economy is growing, investors will move the funds from safe assets to the riskier assets, which give
higher returns. Other factors such as speculation, demand for jewellery, changing government policies, government
borrowing, sentiment, liquidity, safe Haven Buying, manipulation, Rising population affect the price for gold.
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Gold acts as a safe haven during economic crisis and market downturns. The price of gold is not linked to the
performance of an economy, industry or company. Its appreciation is not affected by market volatility.
No entry/exit load. The total expense ratio charged by funds has been a maximum of 1% per annum.
These will not be liable to wealth tax.
A custodian is appointed by the AMC for safe keeping of the gold bought on behalf of the investors.
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Gold ETF:
Gold ETFs are passively managed mutual fund schemes investing in standard gold bullion having 99.5% purity. They
are listed on the stock exchanges for trading with an intention to offer investors a means of participating in the gold
bullion market without the necessity of taking physical delivery of gold. These are designed to provide returns that
closely correspond to the returns provided by domestic price of Gold.
Gold ETF History:
Globally, In May 2003 the first Gold Bullion Security was launched in Australia.
In Nov 2004 the Worlds 1st Gold ETF Street Tracks Gold Trust was launched.
Benchmark Mutual Fund was the first AMC to launch a Gold ETF in India - Gold BeEs in February 2007.
As of today, 14 fund houses have launched Gold ETFs.
The AUM of the category witnessed increasing substantially from Rs.96 crore in March 2007 to Rs. 8,784 crore in
December 2013, representing 1% of the mutual fund industry AUM.
Advantages of Gold ETF:
ETFs have more advantages compared to actively managed funds. They are as follows;
Small denomination: Retail investors, who want exposure to gold in small amounts, can opt for Gold ETFs. It allows
investors to buy one unit, which is buying 0.5 - 1 gram of gold depending on the scheme.
Liquidity: Gold ETFs are can be bought and sold any time during the trading hours like equities at the price quoted
on the exchange. This makes it a liquid investment instrument.
Transparent Pricing: The price of ETFs is quoted on the stock exchange and there is a bid/ask during market hours
enabling you to buy/sell at market prices. Thus you do not have to pay a premium while you purchase or a sell at a
discount as in the case of jewellery or even sometimes in coins and bars.
Safety: Gold ETFs is essentially buying gold in paper form. So the investor does not have to take the trouble of safe
keeping of the gold. The custodian appointed by the AMC has the responsibility of taking care of the gold.
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Purity: Mutual funds are governed by SEBI and SEBI regulations require the purity of underlying gold in Gold ETFs to
be 99.5% fineness and above. This spares investors the trouble of finding a reliable source to buy gold.
Tax Efficient: Gold ETFs do not attract wealth tax. Besides, the investment is categorized as long term if it held for
more than a year unlike physical gold where the period is 3 years.
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Physical Holding by Indian ETFs (tonnes) Vs. Gold India spot price (10g):
Correlation between net inflow in gold ETFs Vs. India Gold Spot Price & Sensex:
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Daily Average traded volume (Rs Crs) of Gold ETFs over the last one year:
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Note: Trailing Returns up to 1 year are absolute and over 1 year are CAGR. NAV/index values are as on Dec 31, 2013.
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Asset growth (Rs Crs) of top traded gold ETFs over periods:
Asset growth (Rs Crs) of gold FoFs having largest AUM over periods:
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Interactive gold price chart (Spot Gold in INR & USD) in the last 3 years period:
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Primary market
Secondary market
Seller
Cash
Authorized
Participants /
FI
Buy / sell
Market making /
Arbitrage
Redemption
in-kind
Creation
in-kind
Fund
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ETF Units
Stock Exchange
Cash
ETF Units
Buyer
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Authorized participants: The fund house appoints market makers in the stock market to execute all the
transactions on behalf of the fund house. The market-makers, also called as arbitrageurs or Authorized Participants
(APs) act as intermediaries between retail investors and the gold ETF sponsor through the exchange. Authorized
participants get creation units from the gold ETF sponsor in exchange of physical gold. Creation unit usually
comprises of 1000 grams of physical gold. Authorized participants then take care of creating the market by
supplying gold ETF units as per the demand. A gold ETF unit usually represents either 1 gram of gold or half gram of
gold so that small investors can buy.
Custodians: The gold ETF sponsor arranges for safe custody of the physical gold. Usually, specialists called
custodians do this job for sponsors for a fee. The gold ETF sponsor is responsible for quality of gold, safety of gold.
The gold ETF sponsor takes adequate insurance for physical gold. The gold ETF sponsor can also invest in money
market instruments upto the percentage mentioned in the offer document. Bank of Nova Scotia, Scotia Macotta
and Deutsche Bank AG are some of custodians of the Indian Gold ETFs.
Arbitrage opportunity: Since the price of gold ETFs is driven by market forces (demand and supply), usually they
trade at a premium or discount to their NAVs (net asset values). The role of the fund houses is to keep the market
price of the gold ETF close to its NAV with the help of Authorized Participants. The Authorized Participants take
advantage of any significant premium or discount between the gold ETF market price and its NAV by doing
arbitrage between the gold ETF and its underlying index.
When an ETF is trading at a discount to its NAV, then the Authorized Participants will buy gold ETF units and then
sell the same to the AMC (in creation units); after taking delivery of the underlying stocks, the Authorized
Participants will sell the same in the markets, thereby benefiting from the arbitrage opportunity. The converse will
be done when an ETF is trading at a premium to its NAV. The arbitrage mechanism ensures that there is no
significant premium or discount to the NAV. At the same time, additional demand/supply is absorbed due to the
action of the Authorized Participants.
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Who will guarantee the purity bought? The authorised custodian (safe keeper) sources gold from LBMA (London
Bullion Market Association) approved refiners on behalf of investors. The amount of physical gold held by the
custodians in all schemes is of fitness (purity) of 99 part per 1000. (i.e, 99.5% pure). The gold held with the
custodian is fully insured.
Tracking Error:
Investors in an ETF buy or sell a security representing shares in the underlying index fund. They do expect the price
of the ETF to closely track the value of the underlying Index. The Schemes returns may deviate from those of their
respective underlying indices. The measure to calculate the deviation is called as Tracking Error. Tracking Error is
defined as the standard deviation of the difference between daily returns of the underlying index and the NAV of
the respective Schemes. For example, a tracking error of 1% implies that if the index return is 10%, the ETF return
should be 9%-11% about 68% of the time.
Tracking Error may arise due to the following reasons; Expenditure incurred by the Fund, Available funds may not
be invested at all times as the Scheme may keep a portion of the funds in cash to meet Redemptions, for corporate
actions or otherwise, Rounding-off of the quantity of shares in the underlying index, Regulations and internal
policies and indirect taxes and etc.
Bid ask Spread: An ideal gold ETF has a low bid/ask spread. Bid means the investor should know the price at which
he can buy units and ask means he should know the price at which he can sell units. The difference between bid
and ask should be very little, in an ETF.
Tax implications on Gold ETFs:
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Discount (+) / Premium (-) of Close Price of Gold ETFs to their NAV:
As the ETFs are passively managed investments, the prices of gold ETFs must theoretically move in tandem with the
price of physical gold. When the price of gold moves up, the value of ETFs appreciates and vice versa.
It is worth noting that like all traded instruments, the traded price of the ETF is influenced by demand and supply
dynamics, and therefore is often different from the NAV of the ETF.
The NAV of the ETF reflects the end of day value of the units based on the holdings of the ETF reflecting the price of
gold, after charging expenses for fund management.
Quite often, the traded prices of the ETF are quite different from the NAV due to low trades and other factors. In
some cases, the traded price of the ETF may be lesser than the NAV of the ETF (discount of close price to the NAV).
That means that a selling trade made on such a day will lead to losses for the investor.
When the traded price is more than the NAV (premium of Close price to the NAV), it means that the unit holder is
getting a price for his units in excess of the actual value of investment.
So any buying on exchange will lead to loss to the investor. This can happen if the demand for units is very high.
Usually a large difference in the price of the traded price and NAV corrects itself over time, offering an arbitrage
opportunity by the market makers.
Even as Gold ETFs hold the promise of providing instant liquidity during trading hours, the poor trading volumes
across some of the ETFs act as a deterrent to such liquidity.
Investors have to be careful on this, however one can not notice such mispricing during the market hours as the
NAV of the day is disclosed post market hours.
The below table lists out the average, minimum and maximum of the premium or discount of the spot price to their
NAVs in the last one year period.
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Discount (+) / Premium (-) of Close Price of Gold ETFs to their NAVs in the last one year period:
The below distribution charts portray the range of mispricing (market price vs NAV) on number of days within the
last year (250 trading days) for the top performing Gold ETFs.
Gold BeES:
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Relationship between NAV, Closing price of ETF on NSE and MCX Spot Price as on Dec 31, 2013:
Why NAVs of Gold ETF from different sponsors are different? Why do Gold ETFs quote at a discount to spot gold
price? One of the probable reasons of the difference seen among the NAVs of Gold ETFs at any given day is that
they were launched in the different periods. The issue price for per unit is fixed during NFO period based on the
spot price of one gram of gold prevailing on the date of allotment (this date generally falls in 15 to 30 days after the
NFO is over). NAVs of such funds appreciate or depreciate by tracking closely the underlying benchmark of price of
physical gold in the conventional market place. As the investment style is passive in nature, the returns are more or
less similar to that of physical gold.
Importantly, the ETFs do invest a very small part of their corpus in short term debt instruments such as call money
and keep it as cash equivalent to maintain liquidity.
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Further, all AMCs charge expenses to the schemes. Such expenses are up to 1.50% per annum. As Gold ETFs are not
allowed to earn money by pledging/loaning the Gold, they are unable to recover the expenses from any source.
Hence as years pass by the NAVs of ETF will dip by the expenses charged to the scheme and get further away from
the spot price of gold.
However for a new investor it does not make a difference as to whether he invests in scheme A at a higher NAV of
scheme B at a lower NAV. He will typically participate in the upside/downside (in % terms) in line with the price of
gold.
HDFC Securities Limited, I Think Techno Campus, Bulding B, Alpha, Office Floor 8, Near Kanjurmarg Station,
Opp. Crompton Greaves, Kanjurmarg (East), Mumbai 400 042 Phone (022) 30753400 Fax: (022) 30753435
Disclaimer: Mutual Fund investments are subject to risk. Past performance is no guarantee for future performance. This document has been prepared by
HDFC Securities Limited and is meant for sole use by the recipient and not for circulation. This document is not to be reported or copied or made
available to others. It should not be considered to be taken as an offer to sell or a solicitation to buy any security. The information contained herein is from
sources believed reliable. We do not represent that it is accurate or complete and it should not be relied upon as such. We may have from time to time
positions or options on, and buy and sell securities referred to herein. We may from time to time solicit from, or perform investment banking, or other
services for, any company mentioned in this document. This report is intended for non-Institutional Clients.
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