Gold ETF Returns: How They Work and What Affects Them

Gold ETFs offer investors the opportunity to invest in gold prices without buying any physical gold. The returns from these ETFs are mainly influenced by changes in the domestic gold price, but costs, tracking error, and other market-related issues can influence the actual returns.
 

The concept of gold ETF returns can be understood by knowing about the working of these ETFs, how they perform, and the factors that impact them.

What Are Gold ETFs?

Gold Exchange-Traded Funds (ETFs) are mutual funds that replicate the performance of gold prices and are traded on the stock exchange. In India, gold ETFs usually consist of physical gold with a specific degree of purity, depending on the investment policy of the fund.
 

Gold ETF units may be purchased and sold through demat and trading accounts like other securities.
 

Gold ETFs provide an option for investors to invest in gold without having to hold physical gold in their possession. Nevertheless, these ETFs carry charges for management of the fund and risks associated with the market.

What Are Gold ETF Returns?

The return on a Gold ETF is the profit or loss that an investor earns through his investment in gold ETF units for a certain period.
 

The main factor affecting the return on a gold ETF is the fluctuation in the local price of gold. In case the price of gold increases, the value of a gold ETF can increase as well. Conversely, if the price of gold decreases, the value of the ETF can also decrease.
 

Nevertheless, the return on a gold ETF may not necessarily be similar to the fluctuations in the gold price due to various costs and other factors.
 

Gold ETF returns can be calculated for various periods, such as daily, monthly, yearly, and over several years.

How Are Gold ETF Returns Calculated?

The performance of gold ETFs can be measured by subtracting the buying price from the selling price after deducting all the expenses.
 

A basic calculation is:
 

Gold ETF Return (%) = [(Selling Price − Purchase Price) ÷ Purchase Price] × 100
 

For example, suppose an investor purchases gold ETF units at ₹100 per unit and sells them at ₹115 per unit.
 

• Purchase price: ₹100 per unit
• Selling price: ₹115 per unit
• Gain: ₹15 per unit
• Return: 15\

This is a simplified example before brokerage, applicable taxes, expense-related effects and other transaction costs.
 

For an actual investment, the final return depends on the investor's purchase and sale prices, holding period, and applicable charges.

Factors That Affect Gold ETF Returns

Several factors can influence gold ETF performance.

Domestic Gold Price Movements

Gold ETFs in India generally track domestic gold prices. When domestic gold prices rise, the value of gold ETF units may increase. When gold prices decline, ETF values may also fall.

Domestic gold prices are influenced by international gold prices, currency movements, import-related costs, taxes, and local market conditions.

Investors can monitor the gold rate today in Mumbai to understand movements in the local gold market.

International Gold Prices

Gold is traded in international markets, and international price trends have an effect on domestic gold prices.

International demand, central bank buying, market psychology, and change in economic outlook can affect international gold prices. Such events can affect the performance of gold ETFs in India.

US Dollar and Indian Rupee

Gold prices on the international market are usually quoted in US dollars. As a result, the exchange rate of the US dollar to the Indian rupee may influence the domestic gold price.

If the rupee falls relative to the US dollar, the cost of imported gold in India may increase, all else being equal. Thus, this may help domestic gold prices.

An appreciation of the rupee may mitigate the upward pressure due to international prices.

Interest Rates and Inflation Expectations

Interest rates could impact the investor demand for gold. Higher interest rates or higher bond yields could cause some investors to prefer interest-bearing investments rather than gold. The expectation of low interest rates could help increase the demand for gold under certain circumstances.

The expectation of inflation could also have an impact on the investor demand for gold. Neither inflation nor interest rate changes would ensure any specific change in the price of gold.

Expense Ratio

The gold ETFs incur expense ratio annually for management fees and operational costs.

This is reflected in the fund's net asset value and can have an impact on performance compared to the gold price.

It is important to examine the expense ratio in the latest scheme documents of the gold ETF.

Tracking Error

Tracking error is the deviation of the performance of a fund relative to its benchmark over time.

The gold ETF may not fully reflect the change in the price of gold due to costs, cash position, valuation,, and other reasons.

A smaller tracking difference may mean that the fund has followed its benchmark more closely in a certain period of time, but past performance is no guarantee for future outcomes.

Market Liquidity and Trading Price

Units of Gold ETF are traded on stock exchanges where prices depend on the level of demand and supply.

The market price can be different from the net asset value of the fund. The bid-ask spread and liquidity can also affect the price at which the investor can buy or sell the units.

These could impact the actual returns that the investor earns.

Gold ETF Returns Over Different Time Periods

There is a wide variation in returns of gold ETFs based on the period under consideration.
 

Short-term returns: Short-term returns such as daily and monthly returns will tend to fluctuate due to fluctuations in international gold prices, foreign exchange rates, and market sentiments.

Medium-term returns: Returns that consider a period of several months or years will represent the cumulative effect of gold prices, exchange rate, and management costs.

Long-term returns: The long-term returns will represent the performance of gold ETFs over a period of several years. However, gold prices may remain high for some time or may fall or remain static for some time.

Investors must consider returns over similar time periods and not depend on a good month or year alone.

Gold ETF Returns vs Physical Gold Returns

Gold ETFs and physical gold both provide exposure to gold prices, but their costs and practical considerations differ.
 

The actual returns from either option depend on purchase price, sale price and the costs associated with ownership.

Gold ETF Returns vs Sovereign Gold Bonds

Gold ETFs and Sovereign Gold Bonds (SGBs) are two different means of accessing gold prices; however, both instruments differ in terms of structure and characteristics.
 

Gold ETFs trade on the stock exchange and usually reflect domestic gold prices. SGBs are government securities that depend on the price of gold and have certain characteristics in terms of maturity and interest rates as per the issue terms of such bonds.
 

Return from each instrument will depend on its structure, market price, duration, and cost/tax considerations.
 

For a more detailed comparison, read our guide on Gold ETFs vs Sovereign Gold Bonds: Which Is the Better Investment Option?.

Taxation of Gold ETF Returns in India

Taxation may have an impact on the end result that one gets from his or her gold ETFs.

The capital gains tax rate will depend on several issues including when the investment was made, the holding period, and the current tax laws. It is important for the investor to know about the current provisions applicable to his or her investment.

It is important to review the current tax treatment before selling off gold ETF units.

Risks Associated with Gold ETF Returns

Gold ETFs have risks associated with market and investment. The value of these funds might decrease due to a decrease in the price of gold and their returns cannot be guaranteed.
 

The risks are:
 

• Market risk: Prices of gold can change significantly.
• Currency risk: The changes in the rupee-dollar exchange rate influence the price of gold within the country.
• Tracking risk: There is a possibility that the ETF will perform differently from the actual gold price.
• Liquidity risk: Certain ETFs have higher bid-ask spreads or lower liquidity.
• Cost risk: Costs of the fund might result in lower returns.
• Opportunity cost: Gold does not produce interest or dividends like some other investments do.
   

Investors must take these risks into consideration along with their financial goals and investment horizon.

How to Evaluate Gold ETF Returns Before Investing?

Some of the aspects to consider before investing in a gold ETF include:
 

1. Previous performance: Analyse performance over different periods, and not just the latest performance.

2. Expense ratio: Evaluate the expenses of the fund.

3. Tracking error: Measure the extent of tracking of the index by the ETF.

4. Liquidity: Evaluate the liquidity of the ETF.

5. Fund size: Evaluate the size of the scheme and its history.

6. Investment objective: Evaluate how the investment in gold will fit into the overall investment portfolio.

7. Taxation: Evaluate the taxation on the investment.
 

Historical performance may give some insight, but it does not predict future performance.