Friday, February 09, 2007

Gold funds in India - Unanswered questions

With the Indian government appoving gold based mutual fund schemes, there is obviously a rush by various mutual fund companies to start Gold funds and Gold ETFs in India. Knowing Indian and their love for gold, this could be a huge success story for the fund houses. There are still a few questions that I don't have an answer for today but it would be good to know.
  1. What is the tax implication for buying gold? Do we get tax rebates for buying a gold MF?
  2. Would a gold MF be treated as an equity MF or a debt MF with associated tax implications?
  3. When I sell my holding in the fund, do I have any extra exit loads because of liquidity risks?
  4. Will the price of the fund ever differ from the gold price? Considering this is more liquid than physical gold and traded mostly electronically, I would imagine that such advantages should allow the price of the fund to be at a premium to actual gold. Would this be the case?
So many unaswered questions in my mind. Any prudent reader would point out that we never asked such questions when we bought and sold gold so why now? The answer is that by bringing a structured investment tool, I would like to peg my risk level to that of buying and holding gold while leveraging the capabilities that a financial instrument can give me. Hence the questions.

You can always buy gold in T.Nagar... that institution would exist as long as Indians abound!

5 comments:

sumal said...

You write well about these issues. What do you think will happen to the markets over the next few months?

Vivek Venugopalan said...

Sumal - Markets have tendency to do one thing best. Keep changing :-). Honestly, I am not a crystal ball grazer. I firmly believe in the capital market system's ability to out perform any asset class in the long run (10+ years) hence I am trying to bring in clarity into that space.

Satish said...

Vivek - Gold MF's are relatively new to the india market with reasonable success in developed markets. From a demand perspective - our consumption pattern is different from the rest of world, we have a high capacity of end consumption as opposed to secondary and tertiary consumptions in other markets. From a investment point of view this is both good and bad - good becuase the demand is always going to be there as end consumers impact gold prices to a degree, bad because of the sheer fact that as a culture we tend of simply "sit" on this asset and this is not a trading tool. So, the price determination is going to be largely international from a supply perspective.

As regards to your other questions, my 2 cents -

What is the tax implication for buying gold? Do we get tax rebates for buying a gold MF?

A - There is a Long term CG applicable after 1 year. If you own gold assets - you will have to pay wealth tax, but with Gold MF's you hold there is no wealth tax implication directly - rather this and other factors such as insurance are built into the cost structure of the MF, so you have read individual offers with a finetooth comb on how they pass on these costs to you as an investor.

Would a gold MF be treated as an equity MF or a debt MF with associated tax implications?

A - These will be treated as non-equity MF's from a taxation perspective.

When I sell my holding in the fund, do I have any extra exit loads because of liquidity risks?

A - This depends on how the fund is structured, but this maybe a risk factor going into your decision and expected tenure for returns that you have in mind.

Will the price of the fund ever differ from the gold price?

A - I guess there should be some correlation between the two.

Considering this is more liquid than physical gold and traded mostly electronically, I would imagine that such advantages should allow the price of the fund to be at a premium to actual gold.
Would this be the case?

Potentially yes, i think we should observe some actual movement before we can spot a definitve trend. Gold F&O is probably a good starting point to observe the trends, though these are long term investment tools - much longer than gold futures.

- Satish Panchapakesan

Vivek Venugopalan said...

Satish - Good points. The tendency of Indian household to accumulate gold is similar to how RBI "intervenes" and buys dollars in the market to keep the exchange rate stable. The day RBI stops doing that the rupee will appreciate against the dollar thereby hurting all those industries which depend on the export market for their topline. A similar analogy extended to gold would be that when the indian population starts dumping their gold, the price of gold will crash (worldwide) thereby having a negative effect on all the Gold ETFs. Today some of the reasons why the ETF will trade at a premium to Gold is the liquidity it offers, size of subscriber base - larger base resulting in more gold being bought and stored away! and the indian ethic.

Anonymous said...

Vivek, i found this elsewhere:

"I was told by a friend that he felt much better owning GLD than physical gold because there were no storage fees, it was more liquid than physical gold in his possession and he did not want it to be stolen. I then asked him WHY he held any gold at all and his answer was "I keep 5% in gold in case of catastrophic problems with the monetary system."

After I finished laughing I pointed out the following risks associated with investment in GLD and not physical Gold:

- GLD is held and controlled by banking institutions that will likely be insolvent in the event of a monetary system failure....RESULT: NO GOLD

- GLD can be liquidated (available cash only) if the Sponsor (World Gold Trust Services) resigns or is unable to perform its duties or becomes bankrupt or insolvent....RESULT: NO GOLD

- GLD can be liquidated (available cash only) if the Trustee (Bank of New York) resigns or is removed ...RESULT: NO GOLD

- GLD can be liquidated (available cash only) if DTC, the securities depository for the Shares, is unwilling or unable to perform its functions...RESULT: NO GOLD

- GLD can be liquidated (available cash only) if the Shares are de-listed from the NYSE ...RESULT: NO GOLD

- GLD can be liquidated (available cash only) if the NAV of the Trust remains less than $50 million for a period of 50 consecutive business days ...RESULT: NO GOLD

- GLD can be liquidated (available cash only) if the Custodian (HSBC) resigns ...RESULT: NO GOLD

- GLD can be liquidated (available cash only) if the authorized Participants (JPM, Goldman Sachs, Etc.) redeem the trusts assets ...RESULT: NO GOLD

- GLD can be liquidated (available cash only) if the Trust fails to qualify for treatment, or ceases to be treated, for US federal income tax purposes, as a grantor trust ...RESULT: NO GOLD

- GLD can be liquidated (available cash only) if the maximum period for which the Trust is allowed to exist under New York law ends ...RESULT: NO GOLD

- GLD shares are "supposedly" held by your broker so you take the brokers default credit risk....RESULT: NO GOLD

Add them all up and I'd say GLD is a VERY risky asset to own in the case of a monetary crisis.

He should just buy physical and hide it in a better place!

All the best."

what are your views?