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Gold ETF – Make Money When Trading at Discount or Premium

Gold ETF or Exchange Traded Fund is a gold holding in Electronic form. Each unit of Gold ETF is equivalent to 1gm of Gold. The price of a Gold ETF is equivalent to the domestic price of the physical gold. Though this post is not about Gold ETF. I will share how to make money from arbitrage opportunity in Gold ETF. Recently, i started investing in Gold through Gold ETF. There are multiple reasons for the same. One of the key reasons was that currently gold is available at a discount through an electronic form. Secondly, the world economic outlook is not looking great. For an investment purpose, Gold ETF has inherit advantage compared to Gold Coins.

How the Price of Gold ETF is Fixed?

Normally the buyer is confused on the price of a gold. Though they understand that price of gold vary with purity. It depends on Gold Karat. Karat is the term used to measure the purity or content of the gold. Therefore, the price of 24k, 22k, 18k, 14k and 9k gold will vary. For more details you can check my post, How Jewelers Cheat Customers?  It is more relevant when you are buying physical gold. You should always hold some % say 7.5% of total investment in Physical Gold. I highlighted the same in my post Physical Gold – Why you should hold it for Emergency Situation. A unit of Gold ETF is off 99.5% purity. It is as good as 24 Karat gold or 23.88 Karat to be more precise.

The price of Gold ETF is a separate topic in itself. For this post, it is important to understand that price of a Gold ETF is linked to the Spot Price of Gold in India. It is near the wholesale price of buying and Selling a gold unit i.e. 1 gm of gold. If you are buying a gold from retail market then you might be paying a huge premium. The reason being you are buying small amounts. Therefore, it is another reason to invest through Gold ETF as the retail premium is discounted.

To share an example, existing retail gold price of 24 Karat gold in Mumbai is 31411.76 for 10 gm gold i.e. Rs 3141.17 for 1 gm of gold. On the other hand, the 1 unit of Gold ETF is available at Rs 2705.05 (GOLDBEES). It is the last traded price of GOLDBEES. GOLDBEES is the NSE Symbol of Goldman Sachs Gold Exchange Traded Scheme. The price of Gold ETF depends on various other factors like underlying assets, active trading (demand and supply), cash component, expenses etc. Similarly, the cost of physical gold also includes various charges like making charges, wastage etc. The comparison is just for reference purpose. The current SPOT Price of the Gold in India is Rs 2765. In other words, a buyer in the retail market is paying a premium of approx Rs 436.12 per gm of gold. Both the wholesale price and Retail Price are relative. The money making opportunity exists if you buy at Wholesale Rate and sell at Retail Price. It is true for every commodity.

NAV of Gold ETF

Here comes the shocker. I can bet 99% of the ETF investors are not aware that ETF providers declare NAV of the corresponding Exchange Traded Fund. The reason being Exchange Traded Funds are similar to Mutual Funds. In other words, they are derivatives of underlying assets. ETF Provider pools the money from investors and invests in underlying assets. In the case of Gold ETF, the Gold is an underlying asset. Under an ideal scenario, the NAV reflects the true or fair value of the ETF.

In ETF, there are 2 types of NAV i.e. Real-time NAV and End of the day NAV. The real-time NAV is also called Indicative NAV or iNAV. The reason for declaring real-time NAV is that the ETF is traded actively on the stock exchange. Therefore, real-time NAV is dynamic in nature and is similar to stock price. The NAV details of Gold ETF is available on the respective website of the ETF Provider. As i am referring to the example of  Goldman Sachs Gold Exchange Traded Scheme in this post, therefore, to check the real-time & end of the day NAV of GOLDBEES Click Here.

Gold ETF – Premium and Discount

Many times you must have read that Gold is trading at discount or premium. It’s a no-brainer that it means either it is trading at a lower value than its fair value (Discount) or at a higher value than it’s fair value (Premium). There is NO premium or Discount in the case of mutual funds as there is only one NAV i.e. end of the day NAV. Whereas in case of ETF, there are 3 values

(a) Current Market Price: It is similar to Stock Price and determined by Market Forces. It depends on the supply and demand in the market. In other words, the current market price is the price at which investor is willing to sell or buy Gold ETF. One of the differences between ETF and Mutual Fund is the price of the unit. In the case of ETF, the current market price (bid/ask) is the price you pay or receive to buy or sell a unit of ETF. Whereas in the case of a mutual fund, end of the day NAV is the final price to buy/sell a unit of Mutual Fund scheme as explained in next point.

(b) End of the Day NAV: It is similar to mutual fund NAV. It is declared every day by the ETF provider once the trading session is over. In other words, after the trading is over ETF provider take stock of assets, liabilities and no of outstanding units & declare the end of the NAV.

(c) Real-time NAV: As we discussed that real time NAV provide the current fair value or market value of the ETF. It is declared on real time basis during the trading session and is dynamic. In the case of Gold ETF, near real-time NAV reflects the spot price movement of gold in India. Though there is always a tracking error because it is impossible to track the price movement as and when it happens.

The derivative of above 3 values is Discount and Premium.

Discount: When the current market price is less than End of the day or Real-time NAV, it implies that underlying asset is trading at a discount. It is because of bearish sentiment. In other words, when the no of sellers are more than buyers then the ETF trades at a discount.

Premium: In the reverse scenario, if the current market price is more than the end of the day or real-time NAV, it means that underlying asset is trading at a premium. In other words, buyers are willing to pay a premium to hold the underlying asset like gold. It is because of bullish sentiment in the market. In the case of premium, the no of buyers are more than no of sellers.

In an ideal scenario, the current market price should be close to NAV i.e. it should reflect fair or market value of the asset. The discount provides an opportunity for investors to leverage the arbitrage opportunity and make money. Let’s check out how to make money.

How to Make Money in ETF When Trading at Discount/Premium

Now you must be wondering i have shared lot of basics and fundamentals but as an investor how do i make money. It was important to share the details pertaining to NAV and Market Price of ETF. Without understanding the basics, we cannot make money. Though i have a lot to share but i only discussed what is relevant for this post.

In the case of ETF, the biggest mistake done by  investors is that they only focus on Current Market Price. Only the hardcore investors discuss the NAV. In fact, if you consider NAV then it is very easy to gauge the sentiments related to underlying assets as we discussed earlier. Continuing with the example of GOLDBEES, the current 3 key values of Gold ETF as we discussed in the previous section are as follows

(a) Current Market Price = CMP = Rs 2701

(b) End of the Day NAV = NAV = Rs 2809

(c) Real-time NAV =iNAV = Rs 2801

(All figs are rounded off)

As a layman, the conclusion is that GOLDBEES is trading at a discount of Rs 100 (3.57%) if we compare the CMP with iNAV. In terms of End of the Day NAV, the discount is Rs 92 (3.27%). This example is a real example. Now assuming iNAV is Rs 2900. In this case, Gold ETF would have been trading at a premium of Rs 99 (3.53%). It is advisable to compare the CMP with iNAV as it provides more precise information on price movements. Please note that this discount/premium will not remain forever. The big operators/market makers identify this arbitrage opportunity and purchase/redeem the units to bridge the gap between CMP and NAV. Let’s check out money making opportunity in case of premium and discount.

Discount: An investor can make money by purchasing units when the Gold ETF is trading at a discount. For example, today the gold ETF is trading at 3.57% discount. The market makers will jump in to buy the units directly from ETF provider and bridge the gap. In other words, there is an assured return of 3.57% lying on the table for retail investors. In past, i observed that this discount was max up to 6% when the gold was completely beaten down.

Premium: Here the money making opportunity is available for existing investors. When the gold ETF is trading at a premium, the market makers will redeem the units directly from the fund house and bridge the gap. In other words, the CMP will drop to NAV level. As a smart investor, you can sell the units and book the additional profit equivalent to premium value. The timing is crucial as you have to book the profit before the market makers redeem units.

How to Maximize Profit in Gold ETF?

It is not a rocket science that an investor should enter when the units are trading at discount and exit in case of trading at a premium compared to NAV. As i keep highlighting that it is impossible to time the market. In the case of Gold, it is easy to predict the gold price based on the global economic scenario. The probability of manipulation is negligible as it is traded worldwide and volatility is less in the case of gold. Assuming i invested when the gold was trading at a discount of 4% and exit when the premium was 4%. During the interim period, the gold returns were 15%. Effectively, my return will be 15%+4%+4% i.e. 23%. In other words, i can book additional return of 8%. It also helps to hedge the risk to the extent of premium and discount provided the gap between CMP and NAV is bridged by market makers.

Limitations of Money Making Opportunity in Gold ETF

Each and every money making opportunity in this world has some limitations and so as Gold ETF. I am listing down a couple of limitations faced by me from my personal experience.

Liquidity:

Worldwide ETF’s are very popular investment vehicle but not in India. The concept didn’t take off very well. Even in the case of Gold that is one of the most popular asset class in India, the AUM of GOLDBEES is just Rs 1661.23 Cr. Last 3 months daily average traded quantity is 13500 units per day. In other words, approx 13.5 Kg gold is traded daily. The current average is HIGH because the gold is in an uptrend. This average may drop to 5000 units during a bearish trend. If you are small investor then it is not an issue but retail investors dealing in huge quantity may find difficult to buy/sell. The authorized participants can buy/sell 1000 units or in multiple thereof directly with the fund. This facility is not available for retail investors. Normally, i found that up to 100 units can be traded easily. In the case of more no of units, you may need to bear some loss both at the time of buy and sell. Usually, Buy and Sell quantities are in single digit for Gold ETF.

Limit of Premium and Discount %:

Here the greed and fear play an important role. I discussed it in detail in my post, Successful Investors – 5 Hidden Secrets to Make Money. In the case of Gold ETF, historical data may come to your rescue. My personal observation is that discount/premium of more than 6% is highly unlikely. Secondly, it also depends on when the sentiments change i.e. become bullish from bearish and vice versa. Though it is difficult to time the market but an investor should buy when sentiments are turning bullish and sell when it is turning bearish. As i mentioned that in the case of gold it is easy to find the change in sentiments compared to stocks that are in the grip of market makers. Stocks can be easily manipulated but same is not true for gold.

Words of Wisdom: In this post i shared an example of Gold ETF that i track very closely. The money making opportunity do exist in other ETF’s linked to the stock market but i observed that retail investors can tap it easily in gold. As i shared Gold is least volatile and price cannot be manipulated by big operators in India. The volatility in Gold increases in case of any volatility in world economic environment. The best examples are Brexit, speculation of US Fed Rate hike, Negative bond yields etc. The gold price and stock market performance move in opposite direction. I will discuss all these points in detail in my future posts. In a nutshell, it is easy for a retail investor to tap money making opportunity in gold compared to any other asset class.

Copyright © Nitin Bhatia. All Rights Reserved.

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Ravi Bhatia
Ravi Bhatia
8 years ago

What a wise iinformative research.

nidhi
nidhi
7 years ago

Hi Nitinji I wish to buy nse gold bonds. Whats ur opinion about it. Since I don’t have a demat acct how I can buy them. Thank u n regards nidhi

Nitin Bhatia
Nitin Bhatia
7 years ago
Reply to  nidhi

Nidhi Ji, You may buy Sovereign Gold Bond Scheme open from July 18-22. Demat account is not required and you can buy in paper form. You can approach any of the nearest scheduled commercial bank or some of the post offices are also authorized. These gold bonds are issued for 8 years and you can exit only during 5th, 6th or 7th year. Govt may list them on exchange for trade but only demat bonds will be traded.

My only concern is on liquidity. If liquidity is not a concern for you and you are investing for min 5 years then you may go ahead and buy.

nidhi
nidhi
7 years ago

thank u very much nitinji

subashpv
subashpv
7 years ago

Hi Nitinji, this may be an old post. But you stated
“Current Market Price = CMP = Rs 2701”
can you provide the link where you verify this. I see so many contradictory links which confuses. Is this same as the spot gold price you were referring to. I know NAV price which is GOLDBEES price which is showing in moneycontrol. Can you please clarify if possible.

Nitin Bhatia
Nitin Bhatia
7 years ago
Reply to  subashpv

The rate i quoted was date on which i posted the article. The NAV and unit price is not same. A unit might be trading at premium or discount over NAV. The Gold ETF price is landing price of Gold in India. As per my understanding it is different from the Spot Price.

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