Gold or Gold ETFs? Does Behavioural Phenomenon Hold Here?

For past couple of weeks, financial markets across the world have seen so many ups and downs caused by a series of events here and there. Some of these events such as Middle East crisis, Japanese Tsunami and subsequent nuclear issues, S&P's degradation of the US government's debt had shown and are still showing significant impact across the global financial markets. Volatility and uncertainty in financial markets is such that S&P CNX Nifty rose about 10% in the past one year, and BSE Sensex rose about 11.51% in the same period. Compared to this Gold has gained 26% in the same period.

Gold has emerged as a better investment alternative compared to stocks/equities. Global political and economic issues have just added some more flavor to this preference. Issues like recent political problems in Israel and North Africa, inflation issues in emerging economies and shallowing interest rates in developed countries have made gold an attractive and safer investment option, and institutional as well as individual investors are equally preferring to put some substantial portion of their portfolio in gold, either in form of physical gold coins and bars, or in gold exchange traded funds (ETFs). Here it would be interesting to note that price of gold have been shooting up in the recent past. Well, first, we should know what a gold ETF is (at least for our friends who have little idea about it). Gold ETFs are exchange traded products that invest in physical gold and continuously track the price of gold. Such exchange traded products include exchange traded funds (ETFs), exchange traded notes (ETNs), and gold closed ended funds (G-CEFs). For investors investing in such exchange traded products, it is very much similar to buying any other security (e.g. shares, bonds etc.), because in this case also they do not need to take or give physical delivery of gold. Investors thus can make investment according to their preferences just as they do with any other security.

Image courtesy: World Gold Council (http://www.gold.org)

So far so good, now you may ask why I've chosen the title of current post as the validity of behavioural phenomenon in gold vs. gold ETFs decisions? Ummm... it is quite possible that you might not gulp down the justification so easily, but, this is exactly what I wanted you to!! To make yourself think about the issue raised in the post!

Globally, there is a debate on whether investing in gold ETFs is different from buying physical gold. Let's put some points here. Like any other exchange traded funds, gold ETF is also simply an exchange traded fund that tracks the price of physical gold. The gold ETF moves in line with the price of gold. For example, if the price of gold goes up, so does the gold ETF, and vice versa. Another issue associated with gold ETF (rather, I must say, with any ETF) is the costs. Technically speaking, the Management Expense Ratio (MER) that covers the costs of managing any fund. Here, gold ETFs have got edge: the cost of gold ETFs is typically about 0.25% compared to that of other ETFs (~0.5% - 1.25%).

Now, we should see the concerns of holding physical gold. Unlike investing gold ETF (where you do not get physical gold), if you invest in physical gold, you get possession of physical gold in form of gold coins or bars. And positive aspects of investing in physical gold are its high liquidity and little credit risk involved; sense of proud belongingness comes attached! Though there is no immediate cash flows like in case of rental income from real estate or dividend from shares, there is likelihood that value of investment in gold  will go up in future.

Now comes the behavioural concerns in the choice between physical gold vs. gold ETF! We in India view gold in an altogether different perspective. In India, affinity for gold is associated with our cultural and religious values. It is considered as a store of wealth in a liquid, easy to access and tradable form, as well as sign of prosperity. A research report of Barclays Capital says that unlike investors in developed countries who are comfortable with holding intangible form of gold in form of gold ETFs, Indian investors are sort of apprehensive about investing in gold ETF, as it does not fulfill the desire of Indians wanting to hold a tangible asset that is no-one else's liability. They said that although Indian market is changing with new innovative investment products, more refining capacity and gold reserves replenished, the cultural affinity for the metal is secure. without a mass embracing of financial products, gold's hold is not going to replaced quickly within the next ten years. It is beleived that the jewelry cushion in India continues to exist and is set to soften gold's move lower when investment demand wanes.

Image source: http://www.trak.in

India has probably the largest fascination with gold than any other country in the world and is by far the world’s largest buyer of gold, accounting for 9.5 percent of the world’s total gold holdings.  More impressive is the fact that current demand from India alone consumes 25% of the world’s annual gold output. Gold is viewed in India as a symbol of power and wealth.  However more so nowadays, the people of India buy gold as a hedge of protection from their own rupee currency and government mismanagement.  Gold is highly valued so much so that it’s not uncommon for an Indian to use their gold jewelry as collateral for a loan.

The market for gold-based ETFs is in its growing stage in India. The asset under management (AUM) for gold ETFs has jumped nearly three-fold to Rs. 4,400 crore (figure as on 31st March, 2011) from  Rs. 1,590 crore (on March 31, 2011), which shows that appetite for buying virtual gold is slowly gaining popularity among domestic investor. There are as many as 11 asset management companies (AMCs) in India offering gold ETFs, including gold ETFs offered by SBI, HDFC, ICICI, UTI, Kotak, Reliance, Quantum, and so on.

Retail investors should take advantage of the growing opportunity of investing in gold ETFs, given the nature of diversity ( from typical securities) gold ETFs offered, the past trends in returns from gold ETFs, and other associated features. Happy Investing!!