The Indian households have an affinity to physical Gold since time immemorial.
The Indian household is the largest holder of the yellow metal globally with an estimated reserve of 24,000-25,000 tonnes accounting for 11% of total Gold reserves in the world as per 2019 report of the World Gold Council (WGC). Indian demand for the precious metal is one of the most imperative component of global demand and supply of the metal.
Gold is perceived to be a symbol of financial security in the Indian households, and is often used to diversify portfolio by investors globally. Gold is considered to be the safest investment haven for empirically when the global economies down rallied, with falling interest rates and crashing of stock markets Gold prices soared as investors increased investment allocation to the yellow metal in their respective portfolios. This empirical evidence comments on the negative correlation between fiscal stimulus, optimistic economic sentiment and high interest rates with Gold prices.
Gold plays a critical role in the financial system of countries-specifically in the foreign exchange management. This dates back to the 19th Century when global trade expanded rapidly and it became difficult to settle trade balance between countries. In the absence of an evolved exchange mechanism between different countries, countries resorted to using Gold to settle their respective trade deficits. However this use of Gold as a medium of international exchange came halted with the end of World War 1 in 1914 as countries used seigniorage-printed money to take care of war expenditures. This primarily led to the Gold not serving as a common anchor to settle trade balances. The flooding of economies with currency was primarily the reason for the Great Depression in the 1930’s. Post the Second World War Britain proposed the idea of the International Clearing Center to keep a track record of exports and imports and they proposed they will use the special unit of Bancor to quantify trade. If the inflows of Bancor were lower than the outflows of Bancor then the country’s currency will be allowed to depreciate. But USA came with the proposal of using US Dollar and Gold to settle the international trade deficits. Even though there was a prospect of US Dollar becoming a global country and providing US the right to superiorly manage its trade balances, being a strong economy and reboust international participant in the global trade, Gold and USD began being used to settle global trade.
This lead to the adoption of Bretton Woods Agreement in 1944. The designers of the agreement were-the British Economist John Maynard Keynes and the then American Chief of International Economist of US Treasury Department-Harry Dexter White. While Keynes was still of the view of having a global clearing house, White emphasized on proposing Dollar and the Yellow Metal as the medium of international exchange. Every country had to peg its currency with US Dollar depending upon the trade with the United States and the US Dollar was then pegged to Gold, thus inherently pegging every currency to Gold. This also led to the emergence of USD as Vehicle Currency and it till date serves the same. The Bretton Woods Agreement also laid the foundation of International Monetary Fund and World Bank. The price established was 35 USD for one ounce of Gold.
The Bretton Wood’s system was demolished in 1970. This was because from 1950’s onwards US resorted to deficit financing to pay for post war reconstruction expenditure. This meant that with limited supply of Gold and immense US Dollars in supply and circulation in the world Economy, US had experienced a decline in its Gold reserves. The other reason was that the Fed Policies would impact the rest of the nations. For instance if the interest rates in the US Economy rose, the global investors would increase demand for dollars to be able to invest in the US Economy. This will increase the demand for dollars and supply of other currencies in the global forex market leading to dollar appreciation and depreciation of other currencies. Also it will become troublesome for central banks to manage and pay for trade deficits.
The abolishment of Bretton Woods Agreement did not completely evade its laid down principles. The US Dollar still serves as the vehicle currency facilitating world trade. This gravely has been negated by countries like Russia and China. The US- China trade war is a clear testimonial to China engaging in dirty float-devaluing Yuan, and giving massive stimulus to exporters to be able to dump its products in global markets while bringing dooms to the local manufacturers.
The Dollar as a vehicle currency is highly volatile to global trade, and the economies are affected more than ever by magnification of spillover effects from trade and economic disruptions in any part of the world. In such a scenario there is a tendency of Central Banks to maintain significant Gold reserves in addition to forex reserves. The forex reserves to make official reserve payments and Gold reserves to shield the central bank’s balance sheet against foreign monetary policies, gain from capital appreciation of Gold, to be able to choose the currency for which they need to maintain reserves etc. These entire amalgamated together enable the central bank’s to coherently manage the global trade, trade balances, deficits in trade balances etc.
In order to desist retail investors from gaining exposure-rather participating in the Yellow Metal investment there are now numerous alternatives except for holding Gold in physical form.
Rather holding Gold in physical form is now more costly. For instance, majority of investment in India by retail investors in Gold via Jewelry which has inherent making charges, storage charges, risk of theft. Along with that one becomes liable to pay 2.5-3% of GST on total bill of jewelry purchase whether it is inclusive of making charges or not.
Holding Gold in the form of 24K biscuits and Bullions isn’t very attractive either as one becomes liable to pay additional long term capital gains tax which is as high as 20.8%.(inclusive of cess introduced in 2019) and in case of short term capital gain one pays tax as per one’s own tax bracket.
The emerging instrument for investment in Gold is digital Gold. UPI applications like Paytm, Phone Pay, and Google Pay etc. provide investors an opportunity to invest in Gold in digital format wherein the minimum amount of investment is a Rupee. These organizations use this pool of money to further invest in Gold Instruments or Gold. They purchase Gold from refining and processing companies like MMTC-PAMP, Safe Gold and Augmont. The tenor from investment is from 5-7 years. At the end of tenor you need to take physical delivery of Gold-which ought to be minimum one gram or an investor can avail the option of selling at the current market prices. The investors can also use Electronically Traded Funds-(ETF). For investing in an ETF they need a demat account. The ETF’s track Gold indices , either invest in physical Gold or in mining and refining companies. The minimum investment is one gram and for delivery minimum investment is one kg. There is advent of Gold mutual funds as well where one can begin investing at minimum amount of INR 500 but doesn’t provide the option of physical delivery.
The most recent, famous and lucrative investment vehicle to invest in Gold is the Sovereign Government Bond (SGB). The SGB’s are 8 year fixed income instrument that have face value equivalent to price of one gram of gold. They are issued by the Reserve Bank of India on the behalf of the Government of India. The SGB’s have a maturity period of 8years with an exit option at the end of five years. The SGB’s provide an income stream in the form of interest at the rate of 2.5% p.a. on a semi-annual basis. The interest is taxable-although there is no tax deduction at source. The most attractive feature of SGB’s is that the redemption value that is derived from the current value of gold is not charged for capital gains. The SGB’s are traded in the secondary bond market as well providing investors the option of exiting as and when the need arises. However, the capital gain becomes taxable if the bong is sold off against the maturity of 8years or exit option of 5 years. The minimum investment for an individual investor is one unit of SGB thus, in monetary terms equal to the value of one gram of Gold.
They are expected to be the most valuable instrument to invest in gold because of the upside of no capital gains tax and because of near no expenditure of holding the SGB in demat form. The capital depreciation from of gold is highly unlikely as is given by the fact that for the last five years gold prices have grown at a compound annual growth rate of 37%.
Thus, it is advisable to invest in the safe investment haven using vehicles other than physical form as it is beneficial not only from individual investment perspective but also rational from macroeconomic perspective.
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