The Pros and Cons of Digging for Gold – a just-like-that guide for the lay-person

For starters, many have not been part of the rally in gold. And, many of these many secretly wish that they were. People want to ride a winner. It’s human nature. Before these individuals wager their life-savings on what is being touted as a winner, they need to understand the how-to and the flip-side portion. Investing is as much about human nature and psychology as it is about salting one’s money away. So, people, win half the battle of investing by attuning your investing style to fit your personality and risk-profile. One doesn’t define one’s risk profile, one discovers it over time. Anything that gives one a sleepless night is outside of one’s risk appetite. Don’t put any money in any such product. And, of course, you are not selling your family silver to get your portfolio going, nor are you putting your daughter’s education money on the line. You invest funds that are extra, i.e. funds that you don’t need over x amount of time, and you decide what this x is. Investing is about you, it’s not about fund managers or financial institutions.

Many like to see their gold in physical form. It’s like when you have a girl-friend. You want her physically around you, and not as some long-distance vibration in the ether. The flip-side is, that there is storage risk (gold, not girl-friend, silly). Gold can get stolen, pal. Also, at the time of purchase, there is contamination risk. If you buy coins, you pay about 20% premium for craftsmanship, which you totally lose out on when you try and sell the coins. And there’s tension when there’s gold lying around, just as there’s tension when there’s a girl-friend lying around…

For those who have the ability to connect to long-distance vibrations in the ether, holding gold in non-physical form is a beautiful option. No contamination risk at time of purchase. No storage risk at the end of the investor. It’s just that there’s no gold to hold onto, just a paper-certificate. If that’s ok with you, go ahead and buy into a gold ETF (exchange traded fund). In India, these are still quite illiquid, so there’s a huge bid-ask difference while buying and again while selling, causing massive slippage on both transactions, so for Indians, this is not a good option. On the plus side, the gold units are puchased in demat form and rest in your demat account until you decide to sell them, just like equity, and what’s more, you can transact online, giving you full power over your investment. Also, the unitary size is of half gram gold, so each unit is very affordable. Over time, as this avenue catches on, the illiquidity will go away. There’s a small management fee of about 1% per annum that’s deducted to compensate for storage of the actual gold and to insure it. A remote flip-side could be that if the fund-house promoting the investment is shady, they could hold spurious metal, and if a scam ensues and the fund-house goes under…….actually this has never happened, so let’s not talk about it. In an ETF investment like this, there is no leverage. If gold gains some, your investment gains a corresponding some. If gold loses some, you lose some. A 1:1 win-loss correlation to gold.

There’s another avenue which offers indirect leverage while investing in gold. We’re talking about gold mutual funds. These buy equity of gold mining companies. When gold moves x units in either direction, the NAV of such a fund moves x + y in the same direction, because the underlying gold mining companies have a huge inventory of gold in their corpus, and are also hugely hedged into the future. I’ve actually seen such an NAV jump 60% when gold had moved up 35%. Careful, same goes for the down-side. Leverage is a double-edged sword. On the plus side, if there’s a mad rush for gold, gold mining companies are going to be quoting off the charts on the upside because of this leveraged correlation. For those who are comfortable with leverage, this is a great option. In India, selling one’s gold mutual fund holding for profit within 1 year of investing can result in a 30% short-term capital gains tax though for this asset class, since the underlying assets are held overseas.

And then there are some who’d prefer to buy equity of specific gold-mining companies, not a whole mutual fund. Here, one needs to differentiate between companies holding mines which yield gold, and companies holding mines where gold has not yet been discovered or where operations will need lots of infrastructure to actually yield gold, but this is not an area for the lay-person, so let’s leave it at that.

Well, happy investing, and you’ll also need to identify whether you are comfortable putting your money on the line when an asset class is at an all-time high, or whether you prefer to wait for a dip. But that’s another discussion, for another time and another place. Bye 🙂


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