Should you avoid investing in gold ETFs with rising outflows?

Investors have pulled out Rs 54 crore in April 2018 from gold ETFs. Also, it has witnessed an outflow of Rs 835 crore, Rs 775 crore, Rs 903 crore, Rs 1,475 crore and Rs 2,293 crore in 2017-18, 2016-17, 2015-16, 2014-15 and 2013-14, respectively. In the last 5 years, returns from gold ETFs have been tepid. Let us first understand what is gold ETFs then understand factors leading to rising outflows and what investors should do in this scenario.

What is gold ETFs?

Simply put, gold ETF is a digital way of holding gold. As against the traditional way of buying gold and storing it in the bank locker or at home. These gold ETFs are exchange traded funds that pool investor money to purchase financial gold. The price of gold is set on commodity exchanges and these ETFs provide a hassle-free means of owning the financial equivalent of gold.

Rahul Jain, Head - Personal Wealth Advisory, Edelweiss Wealth Management explains: “The primary reason has got to do with the movement of gold price. In dollar terms, the yellow metal peaked out in 2011 and by the end of 2015 had lost nearly half of its value. The metal has managed to gain ground from its 2015 lows, but the recovery over the past three years has been quite fragile. In rupee terms, gold has been languishing around the Rs 30,000 (per 10 gram) band for the past few years, thereby not offering much incentive for long-term investors to put money into these instruments.”

To understand the lacklustre performance of gold, one must view gold in the context of other asset classes.

“Gold since the start of the Modi regime has yielded an annualised return of 0.4% a year. Gold in INR has done better, earning 4.0% a year, but even fixed deposits have beaten gold returns handily. In comparison, the equity index has risen 47%, or at least three times as faster. There’s been a change in investor preference, as investors have put aside fears about losing money in equities and bought into the Modi structural reform story. This is another factor leading to outflows from gold ETFs,” says Sunil Sharma, Chief Investment Officer, Sanctum Wealth Management.

It is difficult to quantify if there is a shift from gold to equity, but lower returns is a big factor leading to outflows.

Should you avoid investing in gold ETFs?

Navneet Damani, AVP- Commodity Research, Motilal Oswal Commodities says, “We have not been very aggressive over investment in Gold ETFs, as the exit is not very smooth and liquidity is low.”

Sharma adds, “Gold does not provide a steady income stream, and it is generally considered as hedge against inflation. As inflation remains low today, so again no compelling reason to be investing aggressively in gold ETFs. Finally, the opportunity cost of investing in gold versus investing in equities could be quite high for an economy like India, where GDP is growing in excess of 7%.”

On other side, Jain is firm on recommending gold ETFs to investors. He cites, certain advantages of investing in gold ETFs compare to other options. This advantages are convenience, low on cost, purest quality of gold held by ETFs, etc.

Alternative options to gold ETFs

“We continue to recommend having around 8-10% of your overall portfolio into gold,” says Damani. Instead of gold ETFs you may consider other options such as sovereign gold bonds, gold coins and bars, jewellery, etc.

Is it good time to invest in gold?

Jain says, “We believe the worst is behind for gold. Despite the strong performance from equities and despite the rise in U.S. interest rates, gold has held steady over the past few years, signalling selling pressure in the metal is ebbing. Also with geopolitical tensions lingering in the Middle East and trade tensions between U.S. and China far from over, we feel gold will be one of the key beneficiaries in case any conflicts arise.”

Damani adds, “We retain our bullish forecast for gold. In a slightly more bullish scenario, if global equity markets indeed see a downturn and if volatility spikes, gold could move towards $1470 levels. On the domestic front, Rs 28,800 – 29,300 zones should act as a strong base for the year and an upside move towards Rs 32,500 – 33,300 look likely (8% upside from current price).”

“Historically, gold has shared a negative correlation with equities i.e. when equity markets becomes very volatile, safe-haven demand of gold increases which results in its price going up,” explains Chintan Mehta, Senior Investment Analyst, Morningstar Investment Adviser India. Thus, gold helps cushion the fall in the portfolio value due to equities i.e. it provides diversification benefit.