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Gold, Gold ETFs and Gold Funds

Gold, Gold ETFs and Gold Funds a perspective:
I. Prologue:

January 06, 2012

Gold, an asset class which is neither perishable nor consumed like most other commodities, has been the best performer among all investment options over decades. It 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 13% for the last ten year period. Given its special status of universally accepted medium-of-exchange, gold has been used as the standard for many currencies in history. Gold, which has been used as a symbol for purity, value, status and royalty, has served as both a legitimate hedge against inflation and as an integral part of a diversified investment portfolio. II. History Of Gold: 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. Weight Equivalents:

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III. World Gold market dynamics Production & Supply: The major source of Gold supply is the mine production which contributes around 60% of the world supply and the remaining supply is met through recycled gold. The total gold supply rose by just 1.7% in 2010, as a lower level of scrap-gold recycling and net buying by central banks partly offset mine output growth of 3.8%. The recycled gold supply was at 1,646 tons during last year. As of 2010, approximately 168,300 tonnes of gold have been mined over the course of human history. Seven countries such as China, USA, Australia, Russia, South Africa, Peru and Indonesia produce more than a 1,000 tonnes of gold annually. Data for the first eight months of 2011 from the World Bureau of Metal Statistics show growth in mine production of just 2.5% YoY. Mine production is expected to continue to grow in 2012-13, at an annual average rate of 3%. World Gold Supply:

Sources: World Gold Council (WGC); Gold Fields Mineral Services (GFMS); Economist Intelligence Unit. * - estimated value.

China is the world's biggest gold producer, having raised production every year since 2004. In 2010, output was pegged at 345 tonnes. China's gold production is expected to rise by more than 10% in 2011. During the first half of the year, China's gold output grew by 5.18 tonnes, or 3.25% year on year to 164.42 tonnes. In 2010 Australia produced 255 tonnes of gold and ranked as the worlds second largest gold producer. Australia has more gold reserves than any other country and at current production rates they would last another three decades. The US produced 230 tonnes of gold which made it the worlds third largest gold producer. Commercial-grade refined gold came from about 2 dozen producers. Gold production in the United States is mainly concentrated in the states of Nevada, Alaska, Utah, and Colorado.
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Distribution of gold supply by category:

100%

80%

60%

40%

20%

0% 1970 Mine production 1980 Net producer hedging 1990 Recycled 2000 Net central bank sales 2010 Net disinvestm ent
Data as of 2010

Distribution of mine supply by countries:

Other Countries (20%) China (14%)

Chile (2%) Mexico (2%) Brazil (3%) Papua New Guinea (2%) Uzbekhistan (4%) Canada (4%) Ghana (4%) Indonesia (5%)

Australia (10%)

US (9%)

South Africa (7%) Peru (7%) Russia (7%)

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IV. World Gold market dynamics Demand: Major demand for Gold arises from Investment demand, Jewellery demand, Government reserves & Industry applications. In 2010, the demand for gold was strong in all the four categories and annual demand grew 9% to 3,971 tones. Investment demand comprising of Gold bars, coins, ETFs and physical bar investment grew 56% last year. India is world's biggest gold consumer followed by China and US. Jewellery and investment are the key areas of Indian gold demand. In fact, gold jewellery made up about 75% of total gold demand in India in 2010. Investment demand: Given the proven risk mitigation, hedging and safe haven properties, gold is a natural choice of deploying savings as investors invest in the commodity seeking protection from economic uncertainty. Gold ETFs, one of the major investment options is getting popular among investors day by day. There are other forms of investments in gold like bars, coins, derivatives, spread betting, certificates and others. Holdings in the worlds largest gold backed ETF, Gold SPDRs was at 1280.7 tons in 2010 and had a net inflow of 147 tons. Jewellery demand: India is the largest gold jewellery market in the world & the demand in rupee terms almost doubled in 2010 to Rs1.342 trillion ($29.6 billion) from Rs. 669 billion in 2009. Government reserves: As of March 2011, IMF held 2814 tons of gold & at the time of recent global recession, IMF announced the sale of one eighth of its holdings, 200 tons of which was purchased by India. Declared and undeclared Central bank gold demand continues to be high. Industry Applications: Golds quality of corrosion resistance, medicinal importance & resistance to extreme temperatures is attracting increased number of usages for the yellow metal. World Gold Demands (tonnes):

Sources: World Gold Council.

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Distribution of gold demand by category:

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1970 Jew ellery 1980 1990 Technology 2000 Investm ent 2010

World official gold holdings:

8133

8000 6000 4000 2000 0

Taiwan IMF China India United States Netherlands Venezuela Italy Germany France Russia Portugal Switzerland Japan ECB BIS
3401 2814 2452 2435 1054 1040

837

765

612

558

502

488

424

382

366

323

310

Saudi Arabia

Sources: World Gold Council. International Financial Statistics, December 2011.

As of November 30, 2011, Total World official Gold holding by Central Banks was at 30,732 tonnes.
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1,600

Gold Demand by Global ETFs:

800 Gold Dem and by Global ETFs (tonnes) (LHS) 600 U$/troy oz (RHS) 1,400 1,200 1,000 400 800 600 200 400 200 0
2002 2003 2004 2005 2006 2007 2008 2009 2010

Top gold backed ETFs by size:

Sources: World Gold Council. Data as of 30 Sep 2011.

As of June 30, 2011, the collective holding by global ETFs in gold was at 2,155 tonnes.
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Global Facts: Total above ground stocks of gold as of 2010 (tonnes):

Jewellery

84,100 t

50% 19% 17% 12% 2%

Private Investment 31,400 t Official Holdings Other Fabrication Unaccounted 29,000 t 20,200 t 3,600 t

Total global gold demand as of 2010 (tonnes):

Investment ETFs (9%)

Total global gold supply as of 2010 (tonnes):

Investment Bar & Coin (29%)

Recycled Gold (39%)

Jew ellery (50%)

Mine production (61%)

Technology (12%)
Sources: World Gold Council.

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Sources: World Gold Council. Data as of Dec 2010.

Global majors: Major Exporters:

Canada (4.4% )

Top Producers:
Russia (7% )

Indinesia (6.1% )

US (17% )

China (14% )

US (17%) Australia (13%) Peru (7.4%) Indinesia (6.1%) Canada (4.4%)

South Africa (7% )

China (14%) Australia (10%) US (9%) South Africa (7%) Russia (7%)

Peru (7.4% ) Aust ralia (13% )

US (9% )

Australia (10% )

Major Importers:
Turkey (4.5% )

Top Consumers:
Germany (5% )

Germany (7% )

India (25% )

M iddle East (9% )

India (25% )

India (25%) China (15%) Middle East (10%)

M iddle East (10% )

India (25%) China (18%) US (9%) Middle East (9%) Germany (5%)
US (9% )

Germany (7%) Turkey (4.5%)

China (15% )

China (18% )

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Gold, Gold ETFs and Gold Funds

V. Gold market in India:
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India is world's biggest gold consumer followed by China and US. Indian Households hold more than 18000 tons of gold, the largest amount of bullion holdings in the world. Jewellery and investment are the key areas of Indian gold demand. Indias total gold demand rose to 963 tons in 2010 whereas the Jewellery demand increased to 745.7 tons. In fact, gold jewellery made up about 75% of total gold demand in India in 2010. Given high domestic inflation, gold is also be perceived as an inflation hedge by Indian consumers and investors. The gold jewellery consumption is expected to grow at an average annual rate of 7.5% in 2012-13. Over the past few years, there has been a significant development in Indian gold ETF market though the size of the industry is still small as Indian investors seek greater access to more liquid gold investments. Hence ETFs have gained more popularity among them. The Indian Gold ETF industry offers 12 gold ETFs and 8 gold FoFs whose total AUM as of November 30, 2011 was at Rs. 9,568 crore. India gold demand in tonnes:
1200 1000 800 600 400 200 Net Imports 0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

India gold supply as on 2010 (tonnes):

Other sources Recycled gold

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VI. Applications of Gold:
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Jewellery: Jewellery is one of the major demand factor for the yellow metal and the demand comes mainly from India & China who contribute more than 50% of the world jewellery demand. Technology: The increased usage of gold in technology is because of its qualities such as corrosion resistance (which means protecting the part from becoming rusty), good conductor of electricity which is used in microchips & electronic appliances for connecting. 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 the medicinal purposes. Chinese many years ago started using Gold as an important part of the medicines they prepare for small pox, because of the resistance power & the power to protect against bacteria and to protect from skin allergies. In the US, gold had been known for improving heart and improved blood circulation. Gold has also been used to cure cancers. 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. Gold has infrared shielding capacity and it has prompted many builders to use it in the exteriors windows, which reduce the heat getting inside the building. Adding a gold nano rod to the memory sticks or optical drives can significantly increase the storage capacity, according to research. 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. Golds resistance to extreme temperatures and corrosion resistance are attracting more engineering uses and the demand is increasing. A gold coating on windows provides protection against extreme temperatures. Dental Industry: 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. Setting up of golden tooth is one of the major uses in the dental industry & seen as a status symbol.

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Gold, Gold ETFs and Gold Funds

VII. Factors influencing gold prices:
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High Inflation: During high inflation, investors tend to invest in gold as it is seen as a good hedge against inflation. Rising inflation appreciates gold prices as people start investing in the yellow metal. Interest rates: The demand for gold increases when the interest rates trend down. Lowering interest rates increases gold prices as gold becomes a better investment option vis-a-vis debt products that earn lower interest. Vice versa, peoples tend to keep money in deposit compared to gold when interest rates rise. 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 investment 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. On the other hand the fluctuations in price tend to occur due to changes in demand. Central bank demand: With dollar facing a question mark as regards its value, central banks of most of the developed countries have started to increase their share of gold in forex reserves. At stable/peaceful /economic prosperity times, Central banks may prefer bonds to gold as bonds fetches some interest. Changes in exchange rates: Weaker U.S. dollar usually leads to an increase in world gold prices. This 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.

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Economic data: The macro economic data such as unemployment data, GDP numbers & 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. Speculation: Like any commodity, investors can be caught up in the mood and expectations of the moment. Rising gold prices can become self-fulfilling prophecy as investors pile into gold to take advantage of rising prices. The price of gold can be highly volatile. Other factors such as demand for jewellery, changing government policies, government borrowing, sentiment, liquidity, safe Haven Buying, manipulation, Rising population affect the price for gold.

VIII. Interactive gold price chart:

2,000

Currency: USD. Weight: Oz.

1,500

1,000

500

Dec-78

Dec-80

Dec-82

Dec-84

Dec-86

Dec-88

Dec-90

Dec-92

Dec-94

Dec-96

Dec-98

Dec-00

Dec-02

Dec-04

Dec-06

Dec-08

Sources: World Gold Council.

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Gold, Gold ETFs and Gold Funds

IX. Options for Gold Investment:
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Jewellery: Investing in jewellery may not be considered as investment as jewellery is generally not made from 24 carat gold; it is generally made from 22 carat or 18 carat gold since 24-carat gold is brittle and cannot be set to beautiful designs of jewellery. Investors have to pay for the making charges and wastages. When liquidated, the making charges, impurities and wastage will be cut and investors may end up getting less than what had invested. Gold bars or coins: Government-certified gold coins or bars have purity level of close to 99.9 and they can be sold easily. Banks charge extra for their coins of anywhere between 5% and 10%. Also the bank coins have lesser liquidity as they are not bought back by the banks. World Gold Council coins are coins issued by jewelers who are part of the WGC network. They have lesser premium over the market price (1% to 2%) and are redeemed at the market price when one takes them for selling. Bullion bars are good modes for investment but the minimum investment is much higher. Gold certificates. is a certificate which represents ownership of gold bullion held by a financial institution for convenient and safe storage. There is a fee for storage and insurance. E gold: National Spot Exchange Limited (NSEL), India is offering E-series to invest in gold. Retail investor can trade in commodities especially precious metal like gold in e-form. Like equities one can keep their gold in demat form, which not only saves on insurance cost and locker rent but also one can invest in small denominations Gold Exchange Traded Funds: They are mutual fund schemes, listed on the stock exchanges and traded like shares. The pooled amount is invested in the physical gold. When redeeming the units, investor can go to the fund house or sell in the market and get them converted in to cash. Gold ETFs are proving to be an easier and safer mode to buy gold. The charges are very less and the gold can be accessed electronically. Mutual funds further offer gold fund of funds in which investors can invest as much small amount as Rs. 100 every month. Gold Mutual Funds: Gold mutual funds hold portfolios of gold mining companies and are directly linked to gold prices. They are actively managed as they are handled by the fund managers.

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Gold, Gold ETFs and Gold Funds

X. Why should an investor invest in gold?
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Gold is a metal, which is valued and traded in all the countries of the world. Gold is the most liquid asset in
the world.

An investment portfolio with an allocation to gold improves the consistency of the portfolio making it strong
and stable. Gold provides consistent appreciation on a continuous basis.

Gold has a low correlation with major indices/most other asset classes and hence is a good portfolio
diversifier. Ideally Gold should constitute 8-12% of ones portfolio on a continuing basis.

Gold is a good tactical hedge against inflation. It has outperformed the consumer price index 8 times out of
10 in the last ten years.

Gold is used to hedge currency exposure. It has been a part of portfolios since ancient times to guard against
economic pitfalls or disasters.

Gold act 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 in not affected by market volatility. Gold as an inflation hedge:
40% CPI Inflation 30% Perform ance of Gold

20%

10%

0% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

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Gold as safe haven during crisis:
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60% Nifty 30% MSCI w orld Gold Returns

0%

-30%

-60% Dotcom Bubble (Jan'00-May'02) Unexpected Election (Apr'04Jun'04) Heavy selling by FIIs & DIIs (Mar 06 to Jun 06) Credit Crisis I (Dec'07-May'09) Credit Crisis II (Nov10-Aug'11)

Gold as consistent performer in terms of annual returns:

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XI. 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. They are designed to provide returns that closely correspond to the returns provided by domestic price of Gold. XII. Gold ETFs 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, 12 fund houses have launched Gold ETFs. The AUM of the category witnessed increasing substantially from Rs.96 Crores in March 2007 to Rs.9,568 Crores in November 2011, representing 1% of the mutual fund industry AUM. XIII. Features of Gold ETFs: Investors can buy and sell the units of Gold ETF directly on the stock exchange through a SEBI registered broker. They are held in the demat form just like equities. Gold ETFs give an opportunity to investor to invest in standard gold bullion (0.995 purity) without taking physical delivery of gold nor compromising with its quality. A custodian is appointed by the mutual fund company for safe keeping of the gold bought on behalf of the investors. There is no entry/exit load charged by the fund. The total expense ratio will be a maximum of 1% per annum. These will not be liable to wealth tax.
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Net turnover in gold ETFs on NSE:

45000 Net Turnover on NSE (Rs in Laks) 30000

15000

0
Oct-08 Oct-09 Feb-10 Oct-10 Feb-11 Apr-10 Aug-08 Aug-09 Sep-10 Apr-11 Sep-11 Nov-07 Jan-08 Jun-08 Dec-08 Jan-09 Dec-09 Dec-10 May-08 May-09 May-10 May-11 Nov-11 Mar-08 Mar-09 Jul-09 Jul-10 Jul-11

Correlation between net inflow in gold ETFs Vs. Sensex:

1000 Inflow s into Gold ETFs 700 Sensex 22000 20000 18000 16000 400 14000 12000 100 10000 8000 -200 Oct-08 Oct-09 Oct-10 Feb-09 Feb-10 Dec-08 Dec-09 Dec-10 Feb-11 Apr-08 Apr-09 Apr-10 Aug-08 Aug-09 Aug-10 Apr-11 Aug-11 Oct-11 Jun-08 Jun-09 Jun-10 Jun-11 6000

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XIV. Gold Funds (FoF): Gold Fund of Funds (FoF) are mutual fund schemes (not an ETF) investing primarily in units of gold ETFs. They seek to provide returns that closely correspond to returns provided by the Gold ETF. They are passively managed funds which enable an investor to save in the form of gold in a convenient manner either through lump sum investment or through SIP (Minimum of Rs.100 per month). The face value of the gold funds is at Rs. 10. XV. Features of Gold Fund (FoF): Demat account not mandatory: Investors can invest in gold funds through the regular process of subscription i.e. in physical mode. The subscription through demat mode is an option for the investor but not a mandatory to invest in gold fund. Demat is compulsory in case of gold ETF investment. Cost Effective: Investing in physical mode enables you to invest at a lower cost as the investor does not have to incur the charges for the demat account and brokerage. Liquidity: Investor can subscribe or redeem the units on all business days directly with the Fund. The face value of the gold funds is at Rs. 10. Exit load is charged between 1% to 2% by all gold funds. Apart from the expenses of Gold Funds, they also bear the expenses of the underlying schemes in which the scheme makes investment. Comparison among gold ETF, Gold fund, Jeweller and Bank:

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Performance of Gold ETFs and Gold Funds:
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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 30, 2011.

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XVI. How gold ETFs work?

Primary market

Secondary market Seller

Cash Authorized Participants / FI Creation in-kind Fund Buy / sell Market making / Arbitrage Redemption in-kind

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. 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. 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. How does it work? If 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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XVII. Tracking Error: Investors in an ETF are buying or selling 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. They also want a sense of how closely the ETF returns correlate with those of the index. Tracking error helps out the investors to measure how closely the ETF tracks the underling index. Tracking error is a statistical term commonly used to describe the volatility of returns of a ETF relative to the returns of its benchmark index. It is typically expressed in terms of the standard deviation of the differences between ETF and index returns over a specific horizon. It can be interpreted as the range around the index return in which ETF returns are expected to fall. 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 tells how much an ETF's returns deviate from the benchmark index's returns over any given period of time. An ETF fund manager needs to calculate his tracking error on a daily basis especially if it is open-ended fund. Lower the tracking error, closer are the returns of the fund to that of the target Index. For investors point of view, the lower the tracking error, the better is the ETF. 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. XVIII. Tax implications on Gold ETFs:

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XIX. Advantages of Gold ETFs: 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 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 mutual fund has the responsibility of taking care of the gold. 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. XX. Disadvantages of Gold ETFs: On the downside, there are some disadvantages also associated with ETFs. Demat account: Demat account and brokers accounts are mandatory for an investor to participate in the gold ETF trading as they are traded in stock exchanges. However, no demat and broker accounts are necessary in case of gold funds transactions. Brokerage Charges: The brokerage charges need to be paid when trading in ETFs. It can be minimized by trading less but the very charm of ETFs is destroyed because it is meant for being traded more often than an index fund.

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SIP in ETF is not applicable in ETFs. But gold funds provide the facility to invest through SIP with minimum amount of Rs. 100. True Replication: The ETFs may not replicate the returns of underlying index due to management expenses, cash holding and so on which result in higher tracking error.

XXI. FAQs on Gold ETFs:

Why NAVs of Gold ETF schemes from different sponsors are different? Why do Gold ETFs quote at a discount to spot gold price? The NAVs of Gold Exchange Traded Funds from different sponsors vary from each other as they have been launched in different time periods. The issue price for per unit was 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 fifteen 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 and to meet redemption requirements. All AMCs charge expenses to the schemes. Such expenses are 1% for all schemes except Birla SL Gold ETF (1.44%). 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. So an older ETF will display a higher discount to the spot price. 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 line with the price of gold in equal proportions.
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The following table displays the above facts:

Note: Trailing Returns up to 1 year are absolute and over 1 year are CAGR. NAV/index values are as on Dec 30, 2011.

Why do Gold ETFs quote in the market at a discount to their NAVs? Gold ETFs are can be bought and sold any time during the trading hours like equities at the price quoted on the exchange (NSE and BSE). The AMCs typically appoint certain brokers as Authorized Participants/Market makers to provide continues liquidity. However the actual liquidity and depth depends on the seriousness with which these players do their duties. Illiquidity in wake of lack of buyers/sellers in the market could lead the price of ETF to quote at a discount to their NAVs. This is more the case when there is a sharp rise or fall in gold price in a small period of time. Is Corpus of a Gold ETF important or relevant? Is the movement of corpus over time important? AUM of Gold ETF category has grown remarkably from Rs.96 Crores in March 2007 to Rs.9,568 Crores in November 2011. Part of this reason could be rise in gold prices. In case of schemes that show consistent rise in corpus (say like Gold BeES), the liquidity in the market improves with the passage of time.

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Gold, Gold ETFs and Gold Funds

.

contd

Why is Reliance Gold ETF NAV quoting at a steeper discount to the spot price than others? One probable reason for the 5.9% discount of Reliance Gold ETFs NAV to spot gold price could be that during the initial days Reliance Gold ETF allowed facility of creation/redemption of units in creation unit size to large investors (in addition to Authorised Participants allowed by all Gold ETFs). This facility resulted in the AMC bearing some losses. Subsequently this facility was withdrawn for large investors in February 2009. In the meanwhile its NAV dipped due to this.
10%

Discount of NAV of RELGOLD to spot price since inception

7%

4%

1%

-2%

-5% Mar-11 May-10 May-11 Mar-10 Jul-11 May-09 Nov-10 May-08 Nov-09 Nov-08 Nov-07 Sep-08 Sep-09 Sep-10 Nov-11 Mar-09 Jul-10 Mar-08 Jan-08 Jan-09 Jan-10 Jan-11 Jul-08 Jul-09 Sep-11

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Gold, Gold ETFs and Gold Funds

contd

(Database sources: World Gold Council, AMC Sites, NAVIndia, Ace MF & Newspaper reports)

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