INVEST AND SHINE

A talk on Paper Bullion

Paresh Datta has been a bank teller for the last twenty-five years. His homemaker wife, Rani, and the two daughters completed the family. One day, the couple thoughtfully discussed their plans to start making gold ornaments for their daughter's marriage when the elder daughter, Pari, entered their discussions. Pari is pursuing her graduation and taking a course in personal finance. Baba, you are discussing our marriages while we plan to study further and make our careers. Rani reacted, "That's fine, but then we must start making provisions from our end. Look how gold prices skyrocketed; your father does not have the 'Parash Pathar' (philosopher's stone) that turns anything into gold."

Many readers are familiar with similar discussions directly or indirectly. The recent northward movement of precious metals like gold and silver, their future price trajectory, and their associated development are intriguing; a deeper understanding of these asset classes will help better decision-making.

Gold is the oldest international currency. According to JP Morgan 1912, "Money is gold and nothing else". Physical gold is an element listed in the periodic table, which means that pure gold is always of uniform grade and quality, protecting its value over time. After the Second World War (1945), the US dollar was pegged as the gold standard currency. This decision in the Bretton Woods conference was overturned in 1971 when the US declared they would stop pegging the dollar against gold. This led to policy uncertainty over the early eighties, when gold moved from $ 35/oz in 1968 to $ 850/oz in 1980, growing at a staggering compounded annual growth rate (CAGR) of 30% per annum for twelve years. Silver was also accepted as a form of money in many early societies. However, silver has always played second fiddle to gold as an asset class, as it is widely available compared to gold. Silver prices positively correlated with gold and moved from $ 3/oz to $50/oz during the same 1970 to 1980 period. A short lesson in history establishes the context of investing in these precious metals; as Winston Churchill says, "The further backwards you can look, the further forward you are likely to see".

Let's return our focus to the Datta family conversation. Pari excitedly explains the recent win of the US Republican candidate and the future President's plans to cut federal taxes, control wasteful governmental expenditures, put tariff barriers on trading partners, and re-industrialize the US, among other things. According to her professor, this is the recipe for policy turmoil and may offer a long-term push to gold and silver. By now, Rupi, Paresh's younger daughter, has also joined the familial conversation. She is about to take her higher secondary examination and aspires to be a fashion designer. The discussion on gold has already caught her attention as she asked, "Then how do we buy gold, Pari Didi?". 'Rupi, you don't have to bother buying bullion in physical form'; instead, there are several ways to purchase paper-based gold and silver, exposing you to their price movement without physical ownership and the associated risk. When you need physical gold, sell your paper bullion and buy the physical asset as required.

The asset management companies (AMC) offer three varieties of paper-based bullion. The fund manager may buy, say, a ton of gold, subdivide it into 10,00,000 grams, and issue 10 Lakh units, each representing one gram of gold held by the asset manager. Anyone buying a unit is a beneficiary of the metal's price movement. However, they can't take possession of the metal. If the Investor feels that the price movement achieved the target, he may sell his unit to a buyer through the stock exchange. This is called a Gold Exchange Traded Fund (ETF).

On the other hand, a gold mutual fund or a Gold and Silver Fund of Funds (FOF) invests in ETFs, thereby giving the Investor a beneficial interest in the metals held through them. In the case of ETF, the secondary sales and purchases are made through exchanges, while for MF or FOF, the transactions are between the AMC and the Investor. The gold monetization scheme in India created another visible option: Sovereign Gold Bonds (SGB), where investors may take exposure to price movement and earn interest on the investment. Commodity exchanges offer ways to gain exposure to gold and silver through futures and options trading. While SGB locks in investment for a long time, F&O offers quick liquidity at a considerably higher risk than any other option. Another novel option is to own stocks of gold or silver mining companies or thematic mutual funds invested only in these companies. All these options have risks that need to be understood before investing, Pari added.

It is quite befitting to address the impact of taxation on buying paper bullion. Capital gains on physical bullion attract a long-term tax of 20% post-indexation. However, long-term capital gains tax on metal ETF, Mutual Funds or FOF stands at 12.5% after the initial standard deduction of 1.25 lakh profit per year.

While gold and silver are widely used as jewellery, the central banks of many countries buy gold as a reserve asset. Post-pandemic, gold prices rallied as Indian, Chinese, and a few other central banks bought large quantities of gold. Recently, the RBI made news by bringing almost 200 tons of gold back to India from the Bank of England vault. Silver, on the other hand, is commonly used in various industries. Silver prices rallied, too, backed by massive demand from Industries like green energy and electronics. An informed metal investor keeps track of the demand and supply equations while investing. As an informed and a prudent investor, you core portfolio must have an allocation to Gold & Silver.

Deep within, both parents felt glad, they invested well in their daughters.

This article was published in the widely circulated “The Telegraph” on 25th November, 2024. Please read here

https://epaper.telegraphindia.com/calcutta/2024-11-25/71/Page-9.html.