Is Your Jeweler Dimming the Shine of Your Gold?

With gold prices continuing to stay at elevated levels, buying lump-sum quantities of gold has become unaffordable. To put this in context, when the gold prices were low, people used to buy quite a large amount of gold in one go. With gold prices rising multi fold, buying similar quantities has become indeed difficult on account of budget constraints.

Markets respond to changed behavior

The big shift is well catered by products that facilitate small regular purchases and help buyers accumulate the intended quantity over their respective time horizons. There are various forms available today to build a golden nest. These range from simple structures of buying coins at regular intervals to more structured ones of automated systematic investments or gold accumulation plans.

It is really confusing to opt for the right product. One usually ends up enrolling for unsuitable or inefficient ones. The major issue is that many of these structures are fraught with risk; be it price risk, liquidity risk, counterpart risk or all of the above.

Inefficient and Fraught with risks

Often, it is seen that customers get lured by the bonuses offered by gold savings / accumulation plans offered by many jewellers. The additional installment paid by the jeweller at the end of the term works as an illusion that masks the inherent deficiencies and risks. What the jewellers offer is in some sense a mere combination of a fixed deposit being converted into gold at maturity. The additional installment paid by the jeweller works nothing more than simple interest you would have earned over the period if you had parked in a fixed deposit. Most of the jewellers may use this money to fund their working capital requirement.

The important issue here is that the price at which you would buy gold will be one prevailing at the end of the term. So, if you have started today for a one year plan then you get the gold rate that would be prevailing at the end of the term i.e. one at the end of 12 months from today. If you had enrolled for such plans over the last few years then you would have bought gold at a much higher price than what you had started with. It may benefit you if the gold price is lower at the end of the term but it`s more like taking your chances. The ideal way is to average your cost as you pay each installment. But this doesn`t happen in most of the schemes prevailing currently. Some may offer this but it would attract high and recurring administrative charges.

The other issue with such plans is that they are highly non liquid. Some may even not allow closing before the end of the term. Even if they allow, you will lose your bonus installment. You can only buy gold with the accumulated amount and not use it for any other purpose in case you have an emergency. They would only permit you to buy gold jewelry (not even coins and bars) from their stores only. This is because the jewelry would earn them margins over and above the gold price (retail mark ups) + Jewelry making charges (plus wastage charges).

One of the important reasons you invest in gold is that it is free from counter party risk. Once you enroll in such a scheme you are taking a counter party exposure on the jeweller. Unlike Gold ETFs, the money invested by you is not used to back it with physical gold of equivalent quantities. As mentioned earlier the jeweller may use the amount to fund his/her working capital requirement. A jeweller is running a business and a wrong cycle or a wrong call can lead to huge losses beyond repair which can even stretch to defaults in a worst case scenario. Thus, it is up to you if you would like to entail a counter party exposure and invite associated risks.

The most efficient way to buy gold is...

It is a known fact that Gold ETFs are highly efficient investment vehicles due to a host of advantages it offers. Gold ETF`s are price efficient. One can avoid the huge markups associated with buying physical gold even buying lower denominations as low as half gram. The most important thing to note is that Gold ETFs are backed by physical gold making it as good as gold plus, the hassle free investment in gold it offers. One doesn`t have to worry about the storage, purity and safety of the gold. It is held by the custodian in secured vaults and there is an insurance cover for the entire gold as well.

But, one needs discipline to buy gold ETFs as they are available on the exchange where they are listed. You need to buy it in a similar way you would buy an equity share. So, its not automated, you need to be disciplined to invest on every time period chosen by you to meet your goals.

If you feel that it would be difficult to do it yourself then you can opt for Gold Savings Funds which are nothing but a logical extension to Gold ETFs. Those who want to invest in gold at regular intervals in a systematic manner, can consider gold saving funds (which generally operates like a Fund of Funds (FoF) scheme which invests their corpus into an underlying Gold ETFs), since they offer the SIP mode of investing which provide you with the benefit of rupee-cost averaging and automated investments at regular time periods chosen by you, enabling you to fulfill your gold accumulation target.

The Way forward

The only issue is that with Gold ETFs, you can only get delivery of physical gold above a certain size like 1 Kg and in multiples thereof. And with Gold Savings Fund, it is not possible to do so. Since, these forms are ideal way to own / invest in gold, one should only look at converting it only when they want it for consumption i.e. usage purpose. Say for e.g.: one needs to buy a set of jewelry for their marriage then one can sell their gold funds and use that cash for buying the jewelry. Until then keep them in form of Gold ETFs / Gold Savings Fund. While it will be some time before we in India adopt this method but it is hoped that jewellers start accepting gold ETF units in lieu of jewelry, one wants to buy. Currently as they do exchange jewelry for physical gold; similarly they should extend it to Gold ETFs as well. This will enable to pass on the efficiency and transparency to the actual users of gold.