Taper your gold holding, it’s not gonna shine at all

Tags: Hedge Fund
Globally 2013 has been the worst year for gold exchange-traded funds (ETFs), as a drop in investment demand dragged the price of the yellow metal down. Market data suggest outflows of 720 tonnes of holdings in eight leading gold ETFs. The largest gold ETF in the world, SPDR gold trust ETF, has seen persistent outflows, with its total holdings standing at 804 tonnes now compared with 1,350 tonnes at the beginning of the year.

One of the factors driving gold lower has been bulk selling by institutional investors, who believe the decade-long bull market in the precious metal is coming to an end. Up to one-third of the money in the gold ETFs has been sold, with institutional investors being the vast majority of sellers.

In India, gold ETFs have seen a 22 per cent drop in asset under management from Rs 11,992 crore in December 2012 to Rs 9,325 crore this November, according to data released by the Association of Mutual Funds in India (Amfi).

There has been a strong divergence between the prices of gold ETFs and their net asset values (NAVs). The price of an ETF trades at a 10 per cent premium to its NAV while the NAV itself is almost 5 per cent higher than the international price of gold.

Several factors are responsible for this divergence. First, RBI and the government took a series of measures to curb the current account deficit (CAD) to arrest the rupee fall. As reducing gold imports became a priority, the government hiked the import duty from 2 per cent to 10 per cent. The NAV of a gold ETF is based on the landed cost of the metal in India. When the import duty was raised, NAVs of these funds moved up compared with the international gold price.

The rupee has stabilised and the current account deficit (CAD) is under control now. The Reserve Bank of India (RBI) and the government have started unwinding some of the harsher measures taken earlier. Experts say the curbs on gold imports may also be dismantled soon. The rise in gold smuggling, which has security implications, will eventually force the government to scale back these measures. The negative impact of these steps on the small gold traders and artisans is another factor.

There is no need for investors to panic and exit their investment in gold ETFs or gold funds of funds (FoF) completely. But if you buy a gold ETF or an FoF at this juncture, you are most likely to court a higher risk as the above-mentioned steps may remain in force for some more time.

Investors who hold gold ETFs and FoFs in large quantities — more than 10 per cent of their total portfolios — should also consider reducing their positions gradually.

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