In Focus: Yellow Fervour

The launch of the first gold exchange traded fund (ETF) was watched closely by the global market given that India is the largest consumer of the yellow metal in the world.

Gold ETF offers a unique proposition to investors combining the traditional asset class with the modern dematerialised form of investing. Investors will be able to ride on the price movements of the asset and gradually build their positions without having to take possession of the metal and bother about its safekeeping. Further the ETF will offer liquidity as the units will be traded like shares of companies in a dematerialised form on the National Stock Exchange (NSE).

If returns are anything to go by then a little over 16 per cent yielded by gold over the past year (January 2006-2007) are not very huge but the primary benefit lies in the diversification it offers at the asset class level. The basic rule of achieving optimal diversification involves framing a portfolio where the correlation of returns between the different asset classes is low. Given that the co-relation of returns between the equity markets and gold is very low, the metal lends itself well as an effective tool for diversification. Further, gold has historically provided an efficient hedge against inflation.

Since the units will be traded on the exchange, unlike the open-ended mutual funds, the actual buying and selling price may quote at a premium or discount to the net asset value. However, the difference in the traded price and NAV is not likely to be very large. It is important to note that the NAV will be vulnerable to exchange rate movements, changes in indirect taxes such as custom duties and VAT. While there will be no entry or exit loads, investors will have to bear brokerage charges.

Traditionally, Indian households have indulged in hoarding the yellow metal rather than trading in gold, owing to the 'psychological comfort' that gold offers. Hitherto, a small investor turned either to jewellers or banks for purchasing gold. While banks provide assurance on quality, there is no secondary market for this gold. Most jewellers would buy back the commodity at a high discount. Gold exchange traded funds fill the lacunae of quality considerations, liquidity, safety and convenience in gold investing.

As per the securities watchdog, SEBI's guidelines, the gold traded here would be valued at the AM fixing price of London Bullion Market Association (LBMA) in US dollars, and the metal can be retained only in the form of standard bars, which comply with the good delivery norms of the LBMA.

The first gold ETF launched by Benchmark Mutual Fund managed to mop up Rs 100 crore. What is noteworthy is that Benchmark managed to collect this corpus at a time when gold prices are hovering at seven-month highs.

UTI Mutual Fund is the second fund house to launch gold exchange traded fund (NFO opened on March 1, 2007). Many more fund houses have filed their draft offer documents with the SEBI. A fund of funds scheme in gold exchange traded fund also in the offing.