In case you are planning to buy gold or start saving to buy gold for next Dhanteras, this note will be very useful. It provides you with another alternative which can be more cost effective.
Gold Savings Scheme
Most of you might have heard about gold savings schemes run by almost every jeweller wherein customer needs to put instalment for some months and the jeweller contributes one (or some part of) instalment. At the end of the tenure, customers can purchase gold/ jewellery with the accumulated amount in the scheme at the prevailing gold prices. This is a good scheme in a way as it helps customer to
⦁ Develop savings habit by saving periodically.
⦁ Earn on the periodic amount via contribution from jeweller.
⦁ Create an asset in the form of gold at the end of tenure.
Example of such scheme from one of the jewellers:
So, what’s the catch here? Are there any risks involved? Lets have a holistic look:
1) Counterparty Risk – One of the most important risks customers forget about here is credit risk. What if the jeweller goes bankrupt? There is no guarantee or gold collateral by jeweller when customers subscribe to such schemes. In India, there are many jewellers (even the big chains) who have gone bankrupt and accordingly lot of customers who subscribed to such schemes were left stranded.
2) Gold price risk – What if gold price goes up at the end of tenure? In gold saving schemes, customers don’t get benefit of gold price rise inspite of paying periodic instalment. In fact, many times customer ends up buying gold at higher price at the end of tenure of the scheme.
3) Ancillary cost – Gold price quoted by jeweller is higher than actual gold price & also varies from jeweller to jeweller. This is due to various ancillary cost components which are added to the cost of actual gold price. This includes the jeweller’s mark up on gold price, GST on gold @ 3% and making charges depending on the type of gold purchased.
The price quoted by top jewellers for 24 carat gold coins was ~11% higher than prevailing gold price based on data of 07th November, 2023. Since customers must buy gold from the same jeweller under the scheme, he/she will have no option but to accept the price quoted by jeweller.
Illustration of gold price variation as of 07 Nov, 2023
* this is simply an indicative range sourced from multiple website and public disclosures.
4) Selling price mark up – Buying price of gold is usually lower than selling price for jewellers. Accordingly, customers also need to bear this cost at the time of liquidation of their gold. Also, there is wastage/loss factor in case of jewellery which also impacts selling price.
How SIP in Gold ETF & Gold Fund of Fund can be better alternative to jeweller’s gold savings scheme ?
Counterparty risk:
First, let’s understand what Gold ETF & Gold Fund of Funds are. Gold ETFs are mutual fund schemes that invest in physical gold of 999 purity, and its units are listed on stock exchange for buying & selling. Investor needs to have demat account to invest in Gold ETFs. Gold ETF FoF is a mutual fund scheme that invests into Gold ETFs & investor can invest in the fund like other mutual fund without having need to have demat account. Physical gold is kept in safe custody in vault with insurance in place. Thus, Gold ETF & Gold ETF FoF are backed by physical gold thereby having no counterparty risk.
Pricing:
Gold ETF & Gold ETF FoF valuations are directly linked to the actual domestic price of physical gold. There will be no mark-up or any making charges. Further, GST paid on buying gold can be used to set-off against GST collected at the time of sale. This is reflected in NAV of the fund and accordingly investor gets the benefits. Investor, however, needs to bear expense ratio of the ETF/fund which can go up to 1% p.a. This is still very low compared to 11% premium paid. Thus, investors save additional markup, making charges & other ancillary cost if he/she invests in Gold ETF or Gold ETF FoF.
Gold price movement:
Investor gets units for each instalment based on the prevailing gold prices at that date. Thus, investors can benefit from rising gold prices in ETF/Fund as same gets reflected in NAV of the fund.
Illustration – Which is better using historical evidence?
Let us compare 2 investment scenarios.
⦁ Do 12-month instalment in jeweller gold saving scheme with jeweller contributing 13th instalment. Gold coin is purchased with the accumulated amount at ~10% higher value from jeweller.
⦁ Do 12-month SIP in Gold ETF FoF with 1% expense ratio (max).
Outcome –
⦁ 81% of the time investors have better outcomes in Gold ETF FoF vs jeweller’s gold saving scheme
⦁ 75% of the times investor would have made positive returns from SIP in Gold ETF FoF
⦁ Average absolute returns is ~7%
Some shortcomings of Gold ETF or FoF over jeweller’s gold saving scheme
⦁ Most important shortcoming of Gold ETF or Gold ETF FoF is that it’s tax inefficient. Investor needs to pay tax as per maximum rate of tax based on his/her slab rate on gains in Gold ETF/Gold ETF FoF. In case of gain in physical gold bought from jeweller, investor can enjoy lower taxation rate on long-term capital gains.
⦁ Gold ETF/FoF is good alternative to buying physical gold coin/gold bars for seeking gold exposure. In case investor intends to buy jewellery, gold ETF or FoF may have limited use case.
In a nutshell, Gold ETF or Gold ETF FoF can be better way to take gold exposure as it can help investors save on ancillary cost like making charges, mark-up, storage cost, etc. It is backed by physical gold of 999 purity (24 carat) & prices are linked to actual domestic prices of gold. However, investor needs to note that while gains are not tax-efficient compared to physical gold, it still makes sense from a returns perspective and removes many of the risks involved while owning gold in physical form.
The author, Devang Chawda, is Product Manager, DSP Mutual Fund.
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Updated: 10 Nov 2023, 07:06 PM IST