The Hindu Business Line : Will gold go to godowns?

IN PARAGRAPH 91 of his Budget speech on February 28, 2005, the Finance Minister, Mr P. Chidambaram, spoke of `Gold Units'. He said, "Ten years ago we embarked on the process of ensuring that gold inflows are through the official channels alone. I believe that we are now in a position to introduce `gold units' and create a market for such units."

Thus, the Budget proposed that SEBI ( Securities and Exchange Board of India) permit, in consultation with the RBI , mutual funds (MFs) to introduce Gold Exchange Traded Funds (GETFs) with gold as the underlying asset. Such a move would enable any household "to buy and sell gold in units for as little as Rs 100," and these units could be traded in the same manner as MF units, said the minister.

A day before the year 2005 ended, SEBI discussed the issue at its 101{+s}{+t} meeting. Its press release dated December 30 informs that a committee constituted `to look into all aspects of facilitating the setting up of GETF in India' has recommended two models — the MF custodian bank integrated model, and the warehouse receipt model.

In the first, a custodian bank holds physical gold on behalf of the MF, which sells/buys units to/from a wholesale intermediary based on the value of the gold with the custodian bank; the wholesale intermediary sells/buys the units to retail investors on the stock exchange. The second model postulates the holding of gold warehouse receipts by a custodian bank on behalf of the MF.

Right time, therefore, to learn about GETF. But first, what is an ETF? It is "a security that tracks an index and represents a basket of stocks like an index fund, but trades like a stock on an exchange, thus experiencing price changes throughout the day as it is bought and sold," explains www.investopedia.com.

Index fund or index tracker fund, for starters, is "a portfolio of investments that is weighted the same as a stock-exchange index in order to mirror its performance." Take, for example, an index fund that invests in the Sensex. To perfectly mimic the benchmark index, the fund buys all the scrips that constitute the Sensex, in the proportion of their weights in the index. As a result, investment in index fund gains or loses in sympathy with the Sensex, not counting errors and costs. Constant adherence to the index weightings in the fund is why it is called a passive investment, educates Wikipedia.

An ETF is a hybrid financial product, a cross between a stock and a mutual fund, explains www.mutualfundsindia.com. The site highlights differences between ETF and index fund. One, ETF corpus doesn't swell and shrink, with each entry and exit of investor, unlike as in an open-ended index fund. And two, ETF has the benefit of real-time quotes.

ETF is a happening arena, though the sector is far behind the behemoth that MFs are. At the end of the first 11 months of 2005, ETFs' assets stood at $288.95 billion, according to the Investment Company Institute, up from $226.2 billion at the end of 2004, notes www.iht.com. "That is still just a drop in the bucket compared with the $4.4 trillion in traditional equity mutual funds."

Year 2006 has a first, in the form of an India-specific ETF listed on the London Stock Exchange. And www.etfconnect.com speaks of NMUNI as `the first publicly available index of its kind,' with a focus on `the largest sector in the closed-end fund universe, the national municipal bond sector.'

For a snatch of history, visit www.investorwords.com. The Standard and Poor's Deposit Receipt (SPDR, pronounced `Spider'), created in 1993, was the first ETF. "SPDRs gave investors an easy way to track the S&P 500 without buying an index fund, and they soon become quite popular." The Nasdaq's ETF is the 100 Index Tracking Stock, called the QQQ, which "allows investors to essentially invest in all of the stocks that make up the Nasdaq 100 in a single security".

To the ETF-hungry, there is Walter Updegrave's answer dated December 21, 2005, on http://money.cnn.com to a query whether ETFs are a good choice for retirement portfolio. Also, check the ETF series on www.thestreet.com, including articles such as Roger Nusbaum's `Investors Should Not Live by ETFs Alone' and Gregg Greenberg's `A Tale of Two ETFs'.

ETF variants have been in the air for some time now. For example, in 2002, Benchmark Mutual Fund, which launched India's first exchange-traded open-ended fund, proposed investment in debt securities, with returns linked to gold prices. It was to be called Gold Benchmark Exchange Traded Scheme (Gold BeES).

Investors are likely to focus on ETFs "that track financials, homebuilders and gold, along with a controversial new fund that favours companies based on fundamentals instead of market valuation," predicts www.investors.com in an article `Seven ETFs to watch in 2006'. Press-Enterprise, however, cautions: `Quirky ETF mutual funds shifting into the mainstream'.

GLD has a gold pile

What has been the experience of GETFs? `Gold ETF More than a Flash in the Pan,' is what J. D. Steinhilber wrote in 2004 on www.agileinvesting.com, commenting on the fund's debut on the New York Stock Exchange (StreetTracks Gold with symbol GLD) on November 18. In just two weeks of trading, GLD attracted over $1.5 billion in assets. It is creditable that within months thereafter our Budget 2005 mooted the idea.

Although GLD is the first US gold ETF, the Australian Stock Exchange became the first to market this type of product in 2003, writes Nusbaum on www.fool.com. "Since then both the London and the Johannesburg exchanges have started similar investment vehicles."

Adam Hamilton, writing in 2004, on www.gold-eagle.com cited the Australia Newmont President Pierre Lassonde — that the gold ETF could increase gold demand by 500-1,000 tonnes annually. "This number is enormous and could fundamentally alter the gold scene as current global demand is believed to be 4,000 tonnes on fresh mined supply of 2,500 tonnes," opined Hamilton.

A year later, GLD became `the fastest growing ETF in history,' as www.onlygold.com mentions, citing Rhona O'Connell (www.mineweb.net). Of the global ETFs accounting for about $300 billion in assets, GLD had at the end of its first year about $3.3 billion in assets, "backed with a warehouse containing about 211 tonnes of gold, out of an annual world production of some 2,600 tonnes," thus taking `more than 8 per cent of the world's annual gold output off the market.' Global gold ETFs attracted 38 tonnes of investment in the third quarter; 32 tonnes went into GLD.

Here's an update from www.resourceinvestor.com dated January 2: That GLD added a mind boggling 27.87 tonnes of new metal, from 235.41 to another new high water mark of 263.28 tonnes. "Simply an amazing surge of physical demand, with over 6,96,000 ounces or over 21 tonnes of that surge coming in the last four trading days of the year!"

India ranks top in gold consumption, with a ravenous demand for ornaments. Our consumption grew by 42 per cent in 2005, www.mineweb.net informs.

Success of the new GETF may, therefore, well depend on how far the yellow metal succeeds in moving to warehouses rather than end up in jewel-boxes.

ZeroBase@TheHindu.co.in

D. Murali

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