Golden Opportunities: Why Gold ETFs Shine Bright

By Chintan Haria,

Gold ETFs or Exchange Traded Funds were first launched in 2007, and their assets under management stood at ~Rs.37400 crores as of August 2024. This innovative avenue to invest in gold is seeing renewed interest after its taxation was rationalized in the Union Budget 2024. Gold ETFs now have a shorter holding period of 12 months to qualify for Long Term Capital Gains Tax, compared to physical gold where the holding period is 24 months. Additionally, for new investments made in Gold ETFs, a 12.5% LTCG tax will be applicable after a holding period of 12 months if redeemed after 31st March 2025. Prior to the Budget, gains from these instruments would be taxed at slab rate, irrespective of the holding period.

Further, the reduction in Customs Duty to 6% from 15% made domestic gold cheaper, and thus appealing to buyers. Internationally, prices moved from strength to strength driven by geopolitical tensions, strong central bank buying and anticipation of lower global interest rates, attracting further interest in gold. Richly valued domestic equity markets prone to volatility, too have diverted some flows to relatively stable assets like gold.

Gold ETFs are passively managed mutual funds that aim to track the performance of domestic gold prices, subject to expenses and tracking errors. These ETFs offer the comfort of investing in physical gold and the convenience of stock market investments. Units of a Gold ETF trade on the exchanges and can be bought and sold like shares using a demat account. Each unit of a Gold ETF is backed by 24-carat physical gold. This gold is bought from authorized dealers, stores in professional vaults and insured for loss or theft. This addresses the purity concerns and storage costs associated with physical gold investing. Since the gold is bought by the ETF in larger quantities than a retail investor, gold ETF investors get the benefit of wholesale prices. Gold ETFs being pass-through vehicles receive a Goods & Services Tax credit at the scheme level at the time of sale for the GST paid at the time of gold purchase. This translates to higher returns for the ETF investor compared to physical gold investments which require him to bear the GST cost. Each unit of most Gold ETFs represents 0.01 grams of gold, making it possible to invest in small ticket sizes. While investing in physical gold, investors have to purchase a minimum of 1 gram. Since Gold ETF units trade on the exchanges, they are extremely liquid enabling tactical, real-time buying and selling close to fair prices. This is unlike physical gold, where investors usually end up selling at lower than market prices after deducting making charges, GST and other premiums.

Gold ETFs are thus a smarter way to take exposure to gold with their advantages of assured purity, liquidity, convenience, affordability, price efficiency, and tax efficiency. While choosing a Gold ETF to invest in, one should look out for ETFs with reasonably large assets under management which enable more liquidity, low expense ratios to maximize returns, and low tracking errors to minimize deviation from the benchmark.

Despite the recent price rally, the investment case for gold is strong. Global growth is starting to show signs of slowing, which could disrupt equity markets going forward. Central banks globally, led by the Federal Reserve, have begun to cut interest rates in response. Conflicts in the Middle East and Eastern Europe continue to make markets uneasy. Commodity prices are seeing inflationary pressures from supply chain disruptions in conflict regions and a revival in Chinese economic prospects. All of the above are fundamentally positive for gold which is considered a safe haven and a hedge against inflation. The metal has a low correlation to risk assets like equity which make it an effective portfolio diversifier. Lower interest rates too bode well for gold as the opportunity cost of holding the metal comes down.

This festive season can thus be an opportune time to invest in this precious metal which has the potential to not only limit downside risk in times of market volatility, but also enhance returns. A 10-15% portfolio allocation through Gold ETFs can be built in a systematic and gradual manner to take advantage of any pullback in gold prices.

(The author is Principal - Investment Strategy, ICICI Prudential AMC. Views expressed are author’s own do not necessarily reflect the official position or policy of Outlook Media Group or its employees.)