Investing in Gold Everything You Should Know

Investing in Gold Everything You Should Know

By Raag Vamdatt

www.RaagVamdatt.com

Note: Although the data presented in this eBook is primarily from the Indian market, most of the analysis and the guiding principles would be relevant for investors from markets across the globe.

To give your feedback about this eBook, please click the link below to fill out a survey that takes less than 2 minutes to complete: http://www.raagvamdatt.com/SurveyManager/display/sid/2

© 2007-2011 Copyright www.RaagVamdatt.com This eBook can be distributed freely in its entirety – feel free to pass it on to friends and family if you find it useful. Reproduction of any kind needs express written permission from the author ([email protected]) © Copyright for graphs and diagrams www.Gold.org (World Gold Council) Images on the front page courtesy www.sxc.hu

All facts and figures in the eBook have been derived from publicly available sources. Readers are advised to verify these, and consult their financial planner / financial advisor before making investment decisions.

Table of Contents About the Author: Raag Vamdatt...............................................................4 About www.RaagVamdatt.com.................................................................5 Some User Comments...........................................................................................................5

Some Good Articles from www.RaagVamdatt.com.................................6 Chapter 1: Importance of Gold in Your Portfolio.......................................8 Importance of Gold as an investment................................................................................9

Chapter 2: "Investment" in Jewellery.......................................................11 Why buying jewellery is not the right way to invest in Gold...........................................11 Summary..............................................................................................................................12

Chapter 3: How to Buy Gold.....................................................................14 Option 1: Buying Gold Coins from Banks .........................................................................14 Option 2: Buying Gold Coins / Bars from Jewellers .........................................................15 Option 3: Gold Exchange Traded Fund (ETF) ...................................................................15

Chapter 4: Gold Exchange Traded Funds (ETFs).....................................17 What is Gold Exchange Traded Fund (Gold ETF)..............................................................17 Advantages of Gold Exchange Traded Fund (Gold ETF) ...............................................17 What Do You Need to Invest in Gold ETFs?.......................................................................18 Conclusion...........................................................................................................................18

Chapter 5: Gold ETFs in India....................................................................19 Chapter 6: How Much Should You Invest in Gold...................................20 Feedback...................................................................................................21

Investing in Gold: Everything You Should Know

By www.RaagVamdatt.com

About the Author: Raag Vamdatt

Raag Vamdatt, the author and the person behind www.RaagVamdatt.com, is an MBA in Finance from NMIMS, Mumbai and an Engineer from Gujarat University, Ahmedabad. He is an independent financial planner, and provides online financial planning service at http://www.raagvamdatt.com/myfinancialplan/. He has over 12 years of experience in the field of personal finance and investment planning. He hopes that he can share his experience with a large number of people through his website and his eBooks, so that others can learn from his successes, and his mistakes. For more, please visit “About The Author” at www.RaagVamdatt.com (http://www.raagvamdatt.com/about/)

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Investing in Gold: Everything You Should Know

By www.RaagVamdatt.com

About www.RaagVamdatt.com

www.RaagVamdatt.com is a website that focuses on educating investors, and the public in general, about different areas of personal finance. This covers investment (stocks / shares / equities, mutual funds, ULIPs, gold, real estate, etc), insurance (term insurance, endowment plans, ULIPs, etc), loans (home loans, personal loans, vehicle / auto loans, etc) and many other money-related matters affecting the common man. The site has in-depth (yet easy to understand) articles on topics spanning the entire personal finance spectrum. You can read the articles and improve your understanding of investment avenues, or ask specific questions about your situation and get a customized solution. Yes, you can get free advice for your personal finance issues! There is lots of other useful information about personal finance as well, written in an easy to understand, how-to format. Web-based financial planning service is also provided on the website – you can check the details at http://www.raagvamdatt.com/myfinancialplan/.

Some User Comments “No where in the world can you find such a simple language. It’s damn good!!” “This article is very important for youngsters like me to plan their own future.”

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Investing in Gold: Everything You Should Know

By www.RaagVamdatt.com

Some Good Articles from www.RaagVamdatt.com

Income Tax (IT) Return Filing – Which ITR form to use? (http://www.raagvamdatt.com/Income-Tax-IT-Return-Filing-Which-ITR-formto-use/133/ ) Goal Based Investing (http://www.raagvamdatt.com/Goal-Based-Investing/54/) Direct investment in Stocks versus Mutual Funds (MFs)? (http://www.raagvamdatt.com/Direct-investment-in-Stocks-versus-MutualFunds-MFs/56/ ) Want to retire early? Here’s what you need (http://www.raagvamdatt.com/Want-to-retire-early-Here-is-what-youneed/129/ ) ULIP v/s Endowment Plan for Life Insurance (http://www.raagvamdatt.com/ULIP-vs-Endowment-Plan-for-LifeInsurance/63/ ) Stocks - The winning bet for the long term (http://www.raagvamdatt.com/Stocks-The-winning-bet-for-the-long-term/93/ ) Your Personal Net Worth – Importance & Calculation (http://www.raagvamdatt.com/Your-Personal-Net-Worth-Importance-andCalculation/103/ ) An introduction to home loans and factors to consider (http://www.raagvamdatt.com/An-introduction-to-home-loans-and-factorsto-consider/102/ ) Mutual Funds - Growth or Dividend option? (http://www.raagvamdatt.com/Mutual-Funds-Growth-or-Dividendoption/98/ ) Life after life - Why you should buy Life Insurance

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Investing in Gold: Everything You Should Know

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(http://www.raagvamdatt.com/Life-after-life-Why-you-should-buy-LifeInsurance/97/ ) "Settle" early in life - buy a home when young (http://www.raagvamdatt.com/Settle-early-in-life-buy-a-home-whenyoung/96/ ) Interpreting Price to Earnings (PE) Ratio (http://www.raagvamdatt.com/Interpreting-Price-to-Earnings-PE-Ratio/95/ ) Want to own a company? Buy stock! (http://www.raagvamdatt.com/Want-to-own-a-company-Buy-stocks/113/ ) Systematic Investment Plan (SIP) - A rupee a day, keeps worries away (http://www.raagvamdatt.com/Systematic-Investment-Plan-SIP-A-rupee-aday-keeps-worries-away/108/ ) Start saving early and gain from Compounding - Early bird gets the worm (http://www.raagvamdatt.com/Start-saving-early-and-gain-fromCompounding-Early-bird-gets-the-worm/105/ ) Saving enough is not enough – Effect of Inflation on Savings (http://www.raagvamdatt.com/Saving-enough-is-not-enough-Effect-ofInflation-on-Savings/104/ ) Saving Income Tax – Understanding Section 80C Deductions (http://www.raagvamdatt.com/Saving-Income-Tax-Understanding-Section80C-Deductions/123/ ) Income Tax (IT) Benefits of a Home Loan / Housing Loan / Mortgage (http://www.raagvamdatt.com/Income-Tax-IT-Benefits-of-a-Home-LoanHousing-Loan-Mortgage/121/ ) Real Estate Investment (http://www.raagvamdatt.com/Real-Estate-Investment/119/ ) When you aren't around - Succession Planning - Will and Nomination (http://www.raagvamdatt.com/When-you-are-not-around-SuccessionPlanning-Will-and-Nomination/114/ ) Non-Resident External (NRE) & Non-Resident Ordinary (NRO) Accounts for NRIs (http://www.raagvamdatt.com/Non-Resident-External-NRE-and-NonResident-Ordinary-NRO-Accounts-for-NRIs/124/ ) An Introduction to Car Loan / Auto Loan / Vehicle Finance (http://www.raagvamdatt.com/An-Introduction-to-Car-Loan-Auto-LoanVehicle-Finance/127/) www.RaagVamdatt.com - Financial Planning Demystified

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Investing in Gold: Everything You Should Know

By www.RaagVamdatt.com

Chapter 1: Importance of Gold in Your Portfolio

Indians are known to be gold buyers. India is world's largest gold market Indians buy more gold than people from any other country. Here are some interesting and eye-opening facts: Indians bought 774 tons of gold in the year 2007, up 6% from 2006  India accounted for a little over 20% of the global demand for gold in 2007, worth $17.8 Billion  Indians own more than 15,000 tons of gold - mostly in the form of jewellery. This is around 10% of the entire world's gold stock!  Gold owned by Indians is more than the gold held by US, French and German governments put together! 

Clearly, Indians love gold! But is gold used as an investment? Well, no. As we saw above, most of the gold held is in the form of jewellery - Jewellery accounts for around 70% of India's gold demand. Is holding gold in the form of jewellery a good way of investing in gold? We would examine that shortly. But having gold in one's portfolio is definitely desirable. Why should you have gold as a part of your portfolio? Why should you invest in gold? Let’s see the advantages of gold as an investment.

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Investing in Gold: Everything You Should Know

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Importance of Gold as an investment Negative Correlation With Other Asset Classes Gold has strange price movements - when the price of everything else (like oil, real estate and stocks) is rising, the price of gold is usually subdued. But when the price of other assets is going down, the price of gold strengthens! This is because gold is seen as the safest investment - even safer than investing in government backed securities! After all, as history has shown us, governments can fail. But gold never fails – it is always accepted by everyone. Gold is a universal currency! Therefore, when the prices of other assets are going down, people start investing in gold, seeking safety. This causes the price of gold to increase when the price of other assets is decreasing. Hedge Against Downturns Because of its negative correlation with other assets, gold is also a preferred investment in times of economic slowdowns. When there is a downturn, prices of all other assets decrease, as people lose faith in the future of the economy. But since gold is safer even compared to government bonds, people start buying gold as a hedge. And due to this reason, the price of gold increases in the time of economic slowdowns. Therefore, if you have gold in your portfolio, you would be hedged against economic slowdowns to that extent. Hedge Against Inflation On an average, beats inflation small over the term. the

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gold by a margin long During period

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Investing in Gold: Everything You Should Know

By www.RaagVamdatt.com

1983 to 2005, gold gave a return of 7.8% per year compared to an inflation of 7.6%. Although this is not spectacular, it is definitely inflation beating. The above figure shows movement of gold price with respect to inflation (as measured by Consumer Price Index – CPI). In the period depicted (19702005), gold price has outpaced inflation. But please note that this is an exception and not a rule – generally speaking, gold beats inflation by a small margin over the long term. Remember - Gold has maintained its purchasing power over several millenniums! Gold investment acts as an insurance policy against inflation and economic slowdowns. Considering the benefits offered by gold investment, it is comforting to know that at least you are not paying for this insurance! If you have gold investments, you would lower your overall returns during the times of economic booms, but at the same time, you would preserve your returns in times of economic slowdowns - that's the trade-off we have to make! Thus, we can safely conclude that gold should be a part of everyone's portfolio.

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Investing in Gold: Everything You Should Know

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Chapter 2: "Investment" in Jewellery

Let's summarize some facts presented in Chapter 1: 

Indians bought 774 tons of gold in the year 2007, up 6% from

2006 India accounted for a little over 20% of the global demand for gold in 2007, worth $17.8 Billion  Indians own more than 15,000 tons of gold - mostly in the form of jewellery. This is around 10% of the entire world's gold stock!  Gold owned by Indians is more than the gold held by US, French and German governments put together! 

We also saw in Chapter 1 that owning gold is very important, and desirable, for all investors. But the golden question is - how should one invest in gold? (Remember, there is a difference between buying gold for ornamental value, and buying gold as an investment. Here, we are discussing about buying gold as an investment) The third bullet above says it all: Most of the "investment" in gold in India is in the form of jewellery. But that is not the best way to invest in gold.

Why buying jewellery is not the right way to invest in Gold Making Charges When jewellery is made, the jeweler charges a hefty making charge. It can range from Rs. 60 per gram to Rs. 150 per gram. (The lower end of making charges is applicable usually in case of non-hallmark gold, where purity is always doubtful!).

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Investing in Gold: Everything You Should Know

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Let's say that the making charge is Rs. 100 per gram. With the price of gold being Rs. 1200 per gram, it is a whopping 8.3%! This is like paying an 8.3% entry load for a mutual fund – it means that if you want to invest Rs. 100, your actual investment would end up being only Rs. 91.7. Now that's ridiculous! Liquidation Charges To realize profit on any investment, you have to sell what you bought. Let's consider the time when you want to liquidate your gold holding by selling it. If it is in the form of jewellery, you would have to forego another fraction of the value in the form of "melting charges" or "melting losses". And this is around 5% of the value. How does a 5% exit load for a mutual fund sound? Purity The gold used in jewellery is either 22 Carats or lower. This means that a part of the weight of the jewellery is not gold. You want to invest in gold, and not a mixture of metals, right? Then, why buy something that is not pure gold? Authenticity When bought as jewellery, gold is bought from regular jewelers. This means that you rely purely on the expertise (and honesty!) of the jeweler as far as the quality of gold is concerned. Unless Hallmark gold is used, there is no certification backing the purity of the gold. And this means that you can get a rude shock when you want to liquidate your gold jewellery. Storage and Safekeeping Once you but the jewellery, you have to worry about its storage and its continued safekeeping. This means that you either keep it at home (and remain worried all the time), or rent a safe deposit locker, and pay yearly maintenance fee for it. And the jewellery won’t be 100% safe even in a locker!

Summary So, how does investment in gold sound? 10% making charges, 5% melting charges and doubtful quality!

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Investing in Gold: Everything You Should Know

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Would you ever invest in a mutual fund (MF) which charges 10% entry load, 5% exit load, and whose quality of investments is doubtful? Of course not – because it is simply unwise!! The same way, investing in gold in the form of jewellery is not wise. In fact, it is the worst way to invest in gold due to the reasons discussed earlier. So, how should one invest in gold? Let's move on to the next chapter.

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Investing in Gold: Everything You Should Know

By www.RaagVamdatt.com

Chapter 3: How to Buy Gold

In Chapter 1, we saw that gold is a very important part of any portfolio. It gives stability to the portfolio value during volatile times, because the price movement of gold is usually opposite of the price movements of other popular asset classes. In Chapter 2, we realized that most Indians buy gold in the form of jewellery. If bought for ornamental value, it makes perfect sense. But buying gold in the form of jewellery is the worst possible way to invest in gold! So, how should gold be bought? There are multiple options:   

Gold Coins Gold Bars Gold Exchange Traded Fund (ETF)

Each of these is better than buying jewellery. Of course, each method has its own pros and cons. Let's discuss each in detail.

Option 1: Buying Gold Coins from Banks Banks in India sell gold in many branches. This includes State Bank of India (SBI), ICICI Bank, Bank of Baroda (BoB) and Indian Overseas Bank (IOB), among others. Advantages Banks source their gold from the most authentic sources (For example, VOLCAMBI, Switzerland, which is one of the world’s most renowned precious metal refineries). You can trust the purity, and the weight.  Banks also give a certificate of purity with the gold that they sell. 

Disadvantages

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Investing in Gold: Everything You Should Know

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The price that banks charge for gold is usually 10-15% higher than the market rate. That's way too high! This increase in the cost of acquisition means reduced profit when you sell it!  Banks do not repurchase gold from you. So, when you want to sell, you would have to go to the market, and you would only get the prevailing market rate.  You are responsible for the storage and safekeeping of the gold. 

Conclusion: Buy gold from banks only if you are extremely risk averse – you pay too high a price for getting certified gold.

Option 2: Buying Gold Coins / Bars from Jewellers Jewelers have traditionally been selling gold coins and bars. Advantages You get gold at market rate! You don't have to pay any markup on the prevailing market price.  Jewelers usually buy back gold coins or bars that they have sold in the past - again at the prevailing market price 

Disadvantage There is no guarantee about the quality of gold. The quality totally depends on the reputation of the seller.  You are responsible for the storage and safekeeping of the gold. 

Conclusion: Although buying gold from jewelers is better than buying gold from banks, you need to be really careful while doing this. Before finalizing the jeweler to buy gold from, do some research and find out the firm’s reputation. And buy only from a jeweler who is known for selling quality gold.

Option 3: Gold Exchange Traded Fund (ETF) Buying gold from banks or from jewelers has its own advantages and disadvantages. But one common disadvantage for both is that you would need to buy and store physical gold – and this is a BIG disadvantage. You need safekeeping for it for as long as you own it! And that's where Gold Exchange Traded Funds (ETFs) come in. If you want to invest in gold, a Gold ETF is the best way – just buy gold in dematerialized form, and you can sleep peacefully at night!

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Investing in Gold: Everything You Should Know

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The advantages of Gold ETFs are manifold, and therefore, Golf ETFs warrant a chapter of their own!

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Investing in Gold: Everything You Should Know

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Chapter 4: Gold Exchange Traded Funds (ETFs)

What is Gold Exchange Traded Fund (Gold ETF) In simple terms, you can say that Gold ETFs are like mutual funds - they collect money from many investors, and invest it on their behalf. The difference is that MFs invest the money in shares and debt instruments, whereas Gold ETFs invest your money in physical gold. Gold ETFs buy gold from very reliable sources on your behalf, and take care of its safekeeping. In return, they issue you units of the ETF, each unit representing roughly 1 gram of gold. These units are traded on the stock market, and can be bought and sold like ordinary shares. The NAV of these units fluctuates based on their demand and supply, and usually mirrors the price movement of physical gold. The charges regarding the storage and safekeeping of physical gold purchased on your behalf are deducted from the NAV of the units.

Advantages of Gold Exchange Traded Fund (Gold ETF) Ease: If you want to invest in gold, you just purchase the units of the ETF. The Gold ETF does all the hard work of finding reliable sellers, buying from them, storing the gold and its safekeeping. You just sit back and relax! And if you want to sell, no need to go to the market to a jeweler - just sell the units like ordinary shares on the stock exchange, and you're done! 

Safety: Since gold is not physically held by you, you don't have to worry about its safekeeping! The EFT takes care of the storage and safekeeping. There are no physical certificates to worry about either – it is all electronic. That's a big relief! 

Quality: If you are buying physical gold, your first concern would be to be sure about the quality of gold. With ETFs, that worry is gone too - the ETFs buy only from the most reliable sellers, and so, you are in safe hands! 

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Investing in Gold: Everything You Should Know

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Small Investments: With Gold ETFs, you can invest in as less as 1 gram of gold. Is that possible with any other option of buying gold? This also means that you can make regular (maybe monthly) investments in gold, just like Systematic Investment Plans (SIPs) of mutual funds. 

No Wealth Tax: You need to pay wealth tax on gold that is physically held - be it jewellery, coins or bars. But there is no wealth tax on gold held in the form of Gold ETFs. 

Liquidity: If you want to sell physical gold, you would need to go to the few jewelers available in your area, and would have to settle for the best price offered by one of them. Gold ETFs are traded in an open market in a transparent manner, and they have ample liquidity. This means that you get a price that is very close to the actual prevailing price of physical gold. 

What Do You Need to Invest in Gold ETFs? Buying and selling Gold ETFs is exactly like buying and selling stocks. And therefore, just like for stocks, all you would need is: - An account with a broker, through which you can buy and sell the Gold ETF - A Depository Participant (DP) account, that would hold your Gold ETF units Yes, that’s all it takes!

Conclusion There was a time when shares were issued and traded in physical form. You held share "certificates", and had to "deliver" these certificates to the buyer when you sold your shares. Then, dematerialization came, and all the hassle with holding physical shares was gone. Now, it is time to embrace dematerialized gold in the form of Gold ETFs, and enjoy the benefits of dematerialization all over again!

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Investing in Gold: Everything You Should Know

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Chapter 5: Gold ETFs in India

Gold ETFs are very new in India – the first Gold ETF started trading only in February 2007. Therefore, long term historic data is not available.

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Investing in Gold: Everything You Should Know

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Chapter 6: How Much Should You Invest in Gold

Now that we know how to invest in gold, the obvious question is “How much?”. What percentage of your portfolio should be invested in gold? Well, as a rule of thumb, you should invest around 5% of the portfolio in gold. This investment in gold would act as a solid pillar or core for your portfolio, giving it the strength to withstand economic fluctuations with minimal impact. Of course, this is only a rule of thumb. The actual investment in gold would depend on your tolerance for variation in your portfolio value – the more you invest in gold, the more hedge you would get against inflation and downturns. But at the same time, if the economy is performing well, the returns from gold would be below average, and would drag down your overall portfolio returns. Therefore, carefully assess your risk tolerance, and decide what percentage of your portfolio you would invest in gold. Happy investing!

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Investing in Gold: Everything You Should Know

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Feedback

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