The Modern Gold Rush: Part I – Why Your Locker may be the Wrong Place for Your Wealth

The Fundamental Shift: Physical vs. Financial

For centuries, the Indian approach to gold was simple: buy jewellery or coins, lock them in a vault, and forget them. While this works for cultural or consumption purposes, it is a sub-optimal investment strategy. The friction costs in physical gold are immense. When you buy jewellery, you pay 10–25% in making charges, which is essentially an upfront loss. Even with coins or bars, the "buy-sell spread"—the difference between the price a jeweller sells to you and the price they buy back at—can range from 3% to 5%. Most jewellers levy making charges on gold coins as well. Furthermore, storage costs (bank lockers) and the risk of theft add invisible drags on returns.

"Financial Gold" solves these issues by dematerializing the asset. The primary vehicles for this in India are Exchange Traded Funds (ETFs) and Mutual Funds (Fund of Funds). These instruments track the domestic price of physical gold/silver (usually of 99.5% or 99.9% purity) but remove the friction of storage, making charges, and purity testing.

We urge investors to avoid ‘Digital Gold/E-Gold’ options offered on online platforms since these options are not regulated by SEBI and could result in counterparty and operational risks for investors.

The Mechanics of Gold and Silver ETFs

An ETF is a security that trades on the stock exchange (NSE/BSE) like a regular stock.

• Backing: For every unit of a Gold ETF you buy, the fund house (AMC) holds a corresponding quantity of physical gold in a secure vault.

• Liquidity: They offer real-time liquidity. You can buy or sell units at any point during market hours (9:15 AM to 3:30 PM).

• Prerequisites: You strictly need a Demat and Trading account to transact in ETFs.

• Cost Structure: ETFs are generally the cheapest option, with expense ratios often ranging between 0.1% and 0.5%. However, you must account for brokerage charges and the "impact cost" (the difference between the buying and selling price in the order book), which we will discuss in Part III of our blog.

The Mechanics of Gold/Silver Mutual Funds (FoFs)

For investors who do not wish to open a Demat account or who prefer the discipline of automation, Gold/Silver Mutual Funds are the ideal solution. These are structurally "Fund of Funds" (FoFs).

• Structure: When you invest in a Gold Mutual Fund, the fund manager takes your money and invests it into their own Gold ETF. You are essentially buying a fund that buys an ETF.

• The SIP Advantage: The single biggest advantage of the Mutual Fund route is the ability to set up a Systematic Investment Plan (SIP). You can automate an investment of as little as ₹500/month. Doing this with ETFs requires manual intervention every month during market hours.

• Cost Structure: These funds have slightly higher expense ratios than ETFs because you bear the recurring expenses of the FoF plus the underlying ETF. However, for long-term investors, the convenience of SIP often outweighs this marginal cost difference.

The "Silver" Rush: A Different Beast

Investing in silver requires a different mindset than gold. While gold is a monetary asset (a hedge against inflation and currency devaluation), silver is primarily an industrial metal. Approximately 50-60% of silver demand comes from industries—electronics, solar panels (photovoltaics), and EV batteries.

• Implication: Silver prices are more correlated with the economic cycle. If the global economy booms, industrial demand spikes, and silver often outperforms gold. Conversely, in a recession, industrial demand collapses, and silver can fall much sharper than gold. This makes silver a "high beta" play—higher risk, higher potential reward.

Sovereign Gold Bonds (SGBs) – A sunset vehicle

SGBs have been a compelling way for Indian investors to own gold - offering 2.5% annual interest, sovereign-backing and tax-free capital gains, if held to maturity. However, the opportunity set has narrowed as fresh issuances have been stopped by the govt. As a result, it is not possible to buy SGBs from the primary market thereby pushing investors into thinly traded secondary lots with pricing inefficiencies. Further, recent tax changes have limited the capital-gains exemption largely to original subscribers who hold to redemption, eroding the post-tax appeal for secondary buyers. In this context, gold ETFs or funds may now offer cleaner liquidity and tax clarity for incremental gold exposure, while legacy SGB holdings remain valuable core diversifiers.

Taxation Landscape

Understanding the tax implications is critical for calculating net returns. Following recent amendments in tax laws:

• Short Term Capital Gains (STCG): If you sell your units (ETF or Mutual Fund) before the defined long-term threshold, the gains are added to your annual income and taxed according to your income tax slab.

• Long Term Capital Gains (LTCG):

  • Listed Assets (ETFs): Typically, if held for more than 12 months, gains are taxed at a flat rate of 12.5% (without indexation).

  • Unlisted Assets (Mutual Funds/FoFs): Due to their classification, the holding period to qualify as "Long Term" is generally 24 months. Gains after this period are taxed at 12.5%.

  • Note: Always verify the specific classification of the scheme (Equity-oriented vs. Debt/Other-oriented) in the Scheme Information Document, as tax definitions can be fluid based on the exact percentage of domestic equity holding.

Now that we have cleared the basics, let us learn more about asset allocation of gold in our overall portfolio in Part II of our blog.