Gold ETFs: Gold Exchange Traded Funds - A Complete Guide

Thinking of buying gold as an investment but worried how to keep it safe? Why not consider investing in a gold ETF rather than purchasing physical gold?

In this article, you will learn what a gold ETF is and how you can invest in it, among other details.

What Is a Gold ETF?

A gold ETF is an exchange-traded fund that exclusively invests in gold. Like all other ETFs, gold ETFs are traded on stock exchanges just like shares. However, these are funds consisting of different assets, and here in the case of gold, they comprise gold derivative contracts.

A gold ETF consists of futures or options contracts, with the underlying asset being gold. Though you will not own any physical gold by buying these gold ETFs, you can profit from the price fluctuation of physical gold in the market, as the price of gold ETFs depends on the price of physical gold.

Types of Gold ETFs

Gold ETFs are primarily categorised based on how they track gold prices. The most common type is physical gold ETFs, which invest directly in physical gold bullion. Each unit of these ETFs typically represents a fixed quantity of gold, usually one gram.

Another type is synthetic gold ETFs, which use derivatives like futures and options to replicate the performance of gold prices without holding physical gold.

Some ETFs are also international gold ETFs, which invest in foreign gold markets and may hedge against currency risk. Additionally, there are fund-of-funds (FoF) gold ETFs, which invest in other gold-related mutual funds. These offer indirect exposure to gold and can include a mix of physical and derivative-backed gold holdings.

Who Should Invest in Gold ETFs?

Gold ETFs are ideal for investors who want to diversify their portfolio without owning physical gold. They suit individuals looking for a hedge against inflation, currency fluctuations, or geopolitical uncertainties. Investors with a medium- to long-term horizon and a moderate risk appetite can benefit from gold ETFs’ liquidity and transparency. They are also a good fit for those who prefer investing through demat accounts and want to avoid storage, insurance, or purity concerns associated with physical gold. Additionally, investors seeking a tax-efficient and low-cost way to gain exposure to gold prices can consider gold ETFs as part of their asset allocation strategy.

How Can You Use Gold ETFs?

As you may know, gold significantly helps hedge financial risks in a volatile market. It is a saviour for investors when the market crashes. You can use gold ETFs to hedge financial risks, economic and geopolitical fallout, and even against forex risks.

You can also use gold ETFs to hedge against volatility in the physical gold market. If the market price of gold rises and affects an investor, having gold ETFs can reduce the risk to some extent. On the other hand, you can benefit from the falling gold market by trading an inverse gold ETF.

The takeaway is that over extended periods of crude price fluctuations, stocks do not take a different path since there are many other influences on the stocks. On the other hand, for a shorter period, the inverse relationship is much stronger.

One key advantage of gold ETFs is their ease of trading and high liquidity, allowing you to buy or sell units just like stocks during market hours. They also provide a cost-effective way to invest in gold without the hassles of storage, insurance, or purity concerns.

Additionally, gold ETFs are regulated and backed by physical gold, ensuring transparency and security. This makes them an attractive option for conservative investors seeking a reliable hedge without compromising on flexibility.

Disadvantages of Investing in Gold ETFs

While gold ETFs have their advantages, they also come with some drawbacks. One of the primary disadvantages is the absence of physical ownership, which may not appeal to traditional investors who value holding tangible assets. Since gold ETFs are traded on exchanges, they are subject to market volatility and may slightly deviate from actual gold prices due to tracking errors and fund management fees.

As an investor, you must also pay brokerage charges and annual expense ratios, which can erode returns over time. Another limitation is that gold ETFs may not generate any interest or dividends, unlike fixed-income instruments. Additionally, you need a demat and trading account to invest, which may be a hurdle for beginners.

During market disruptions or low liquidity periods, executing large trades could become difficult or result in unfavourable prices. Lastly, unlike physical gold, you cannot use gold ETFs for personal purposes such as gifting or pledging as collateral in certain informal financial settings.

Gold ETFs vs Physical Gold

How Are Gold ETFs Taxed?

Gold ETFs are taxed as non-equity mutual funds in India. If they are held for less than 12 months, any gains are treated as short-term capital gains (STCG) and taxed as per the investor’s income tax slab. If held for more than 12 months, the gains qualify as long-term capital gains (LTCG) and will be taxed at 12.5% without indexation benefits. Additionally, no GST is applicable on buying or selling gold ETFs, unlike physical gold. Dividends, if any, from gold ETFs are added to income and taxed as per the applicable slab rate.

How to Sell or Redeem Gold ETFs?

Selling or redeeming gold ETFs is simple and can be done through a trading account on any stock exchange where the ETF is listed. Just like shares, you place a sell order during market hours, and once the transaction is completed, the proceeds are credited to your bank account. The price is based on the current market rate of the ETF, which closely tracks the price of physical gold. Unlike gold mutual funds, gold ETFs do not allow redemption in physical gold for retail investors. Ensure sufficient liquidity and a favourable bid-ask spread before executing large sell orders.

Things to Consider While Investing in Gold ETF

There are certain things you need to be aware of while investing in gold ETFs-

• Gold ETFs can be more profitable than other investment vehicles with the underlying asset as gold, especially when you regularly invest large amounts.
  
• Since these are funds, there are fund managers as well. Picking a gold ETF purely because the fund has a lower expense ratio or the fund manager's fee is low is not a prudent call.
  
• Investing in gold ETFs can prove beneficial for the short or medium term.
  
• Always check the fund’s tracking error, which indicates how closely the ETF mirrors the actual price of gold. A lower tracking error means better performance in line with gold prices.
  
• Evaluate the ETF’s liquidity by looking at its trading volumes. Higher liquidity ensures smoother buying and selling with minimal price impact.
  

Conclusion

Investing in Gold is nothing new in India, but investing in Gold ETFs is slowly gaining visibility. Gold ETFs combine the traditional appeal of gold with the convenience of modern investing. They offer flexibility, transparency, and ease of trading, making them suitable for both new and seasoned investors. With no concerns about purity or storage, as an investor, you can focus purely on returns. As financial awareness grows, gold ETFs are emerging as a preferred choice for smart, long-term wealth building.

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Gold ETF vs Gold Mutual Fund