Gold ETFs v/s Physical Gold: Understanding the smarter way to hold gold today!

Introduction:

If gold is a part of your investment plan, should it be bought physically or through Gold Exchange-Traded Funds (gold ETFs)? Investors today have more ways to gain exposure to gold beyond just physical gold holdings. Apart from investing in physical gold, such as coins and jewellery, investors can also access gold through financial instruments like Gold Exchange Traded Funds (Gold ETFs). While both represent exposure to the same underlying asset, their structure, costs, accessibility, and regulatory treatment may differ. Understanding these differences may help in evaluating how each form of gold holding could fit into the investor’s overall portfolio.

What are Gold ETFs?

According to AMFI (Association of Mutual Funds in India), “Gold ETFs (Gold Exchange Traded Funds) are passive investment instruments that are based on gold prices and invest in gold bullion.” They are mutual fund schemes that are listed and traded on stock exchanges. These funds aim to reflect the domestic price of physical gold prevailing in the market. However, the actual returns may differ due to factors like fund expenses, tracking error, etc.

How do Gold ETFs work?

a. Each unit of a gold ETF represents a fixed quantity of gold.

b. In accordance with the regulatory norms, these funds invest in physical gold of high purity, which lies in the safekeeping of authorised custodians.

c. Units are bought and sold through a DEMAT (Dematerialisation account) and a trading account.

Thus, when an investor purchases one unit of a gold ETF, it may provide him with exposure to gold without physically holding coins, bars or jewellery. It is also important to note that gold ETFs are passively managed and do not invest in gold mining companies or related equities. In short, gold ETFs provide market-linked exposure to gold through the regulated mutual fund framework.

What is Physical Gold?

a. Physical gold means the gold held by an investor in tangible form, such as coins, bars, or jewellery.

b. Gold jewellery often involves design and workmanship costs, which may not be recoverable at the time of resale. On the other hand, coins and bars may involve low making charges but still require secure storage.

c. Physical gold is typically purchased from jewellers, banks or authorised dealers.

d. The prices of physical gold depend on various factors, such as purity, making charges, and local taxes.

e. The purity of physical gold is typically measured in karats, such as 22K or 24K.

f. Physical gold may require storage that involves home safekeeping or bank lockers.

g. Thus, before investing in physical gold, investors may consider factors such as purity verification, storage arrangements, and insurance, as these may influence overall cost and convenience.

Gold ETFs v/s Physical Gold: Key Differences

Both gold ETFs and physical gold give the investor exposure to the same underlying asset, gold. However, the way they are structured, purchased, stored and taxed may differ. These differences may arise from factors such as ownership format, transaction process, associated costs and regulatory framework.

The table below outlines the key differences between gold ETFs and physical gold.

Can gold ETFs be converted to Physical Gold?

When investors think of investing in gold ETFs, one of the things that they want clarity on is whether gold ETFs can be converted to physical gold. In short, no. Gold ETFs do not provide direct conversion into physical gold for retail investors. However, large institutional investors or authorised participants may redeem units directly with the fund in large specified quantities, which may involve delivery of physical gold, subject to scheme provisions. Thus, when an investor redeems a unit of a gold ETF, the transaction is settled in cash and does not involve the delivery of physical gold. SEBI regulations focus on ensuring that gold ETFs are backed by physical gold, which is held by the fund, rather than enabling physical delivery to investors. Thus, gold ETFs function as a financial exposure to gold rather than a means to acquire physical gold. While the underlying asset of gold ETFs is physical gold, conversion of it into jewellery, coins, or bars may not be a standard feature of this fund.

Benefits of Gold ETFs and Physical Gold

Both gold ETFs and physical gold offer numerous benefits to investors. Since they differ in how the gold is held, accessed and managed, they offer varying potential benefits as follows:

Benefits of Gold ETFs:

a. Dematerialised form: Units are held in a DEMAT account in an electronic form, thus reducing the need for physical storage. This also eliminates the risk of theft or other such concerns.

b. Tax efficiency: Gold ETFs usually do not attract STT or wealth tax during redemption. Only the capital gains tax is levied according to the holding period.

c. Investment in high-purity gold: Gold ETFs are typically backed by physical gold having a purity of at least 99.5% or more, in line with regulatory norms.>

d. Cost efficiency: Unlike physical gold, ETF investments do not involve making or wastage charges.

e. Transparency in holdings: Portfolio disclosures are made periodically as per SEBI regulations.

f. Ease of transactions: Purchase and sale of gold ETFs can be carried out electronically through a trading platform during market hours.

Benefits of Physical Gold:

a. Tangible ownership: Gold is held in physical form, such as coins, bars or jewellery.

b. No market account required: Purchase of physical gold does not require a DEMAT or trading account.

c. Personal and cultural use: Jewellery may serve both ornamental and investment purposes.

d. Inflation and currency hedge: Gold historically retains its value, thus protecting the purchasing power when currency devalues or inflation rises.

e. Flexible purchase quantities: Can be bought in small denominations, according to the buyer’s financial position.

f. High liquidity and portability: It is a globally recognised asset and can be easily sold or converted to cash.

Thus, both forms offer distinct features and benefits. Understanding the nature of both and evaluating them carefully may help the investor to choose between them according to their financial goals and objectives.

Gold ETFs may be considered by investors in situations such as the following,

a. Preference for electronic holding: Where investors prefer to hold gold in dematerialised form rather than physical possession.

b. To avoid storage concerns: When the investor does not wish to arrange physical safekeeping or locker facility for gold. This may also eliminate the risk of theft.

c. Standardised purity exposure: When the investor prefers gold backed by regulated purity standards under mutual fund guidelines.

d. Market-based access: When the investor prefers buying and selling gold through recognised stock exchange platforms

e. Portfolio integration: When an investor wants to expand their financial portfolio as it can be held alongside other financial investments in a DEMAT account.

Physical gold may be considered by investors who value direct ownership and tangible possession. It may be relevant in the following circumstances.

a. Preference for physical holding: Where investors are more comfortable owning and storing a tangible asset rather than holding it in a financial form.

b. Long-term household holding: Where gold is being passed from one generation to the next as a family asset.

c. When they do not want to rely on market infrastructure: An investor with no trading or DEMAT account may opt for transactions with jewellers or authorised dealers.

d. Immediate physical access: When the investor needs direct possession of gold for personal or cultural reasons.

Conclusion:

Even today, gold continues to be one of the widely recognised asset classes. While its role may differ across households and portfolios, it continues to hold relevance across various situations. When deciding between gold ETFs and physical gold, investors may need to look beyond price differences and consider factors such as form, cost, liquidity and intended use. While gold ETFs offer a market-linked, DEMAT-based route, physical gold provides tangible ownership and traditional value.

Ultimately, the choice depends on how one prefers to access and hold gold. Understanding these differences may help investors make more informed decisions aligned with their individual preferences and requirements.

FAQs:

1.Can I convert ETFs into physical gold?

Gold ETFs do not allow direct conversion into physical gold for retail investors. Units are typically sold on the stock exchange and settled in cash at prevailing prices, as per the scheme features.

2. Which has better tax efficiency for the long term?

Tax treatment for Gold ETFs and physical gold may broadly fall under capital gains taxation, subject to holding period and prevailing tax laws. Investors may refer to current income tax provisions or consult tax advisors for clarity.