Dhanteras Special. Glittering options

Gold is a good diversifier in an investor’s portfolio since it is negatively correlated with equities. Increasing geo-political risks ensure that the metal maintains its shine. Prices hit a high of $1,349/ounce in September and have declined to $1,293/ounce since then as the dollar strengthened. But given than the tension between the US and North Korea can ratchet up any time, gold appears poised to edge higher.

In India, since it is auspicious to buy gold on Dhanteras, here’s an outlook on gold and the new options available to bet on the metal.

Outlook Gold is a classic safe haven in times of uncertainty and turmoil. The rally in the price this year from about $1,220/ounce in July to $1,349/ounce in September was stoked by the geo-political uncertainty. Since then, as the dollar gained steam, gold has given back its gains.

However, over a one-year period, the outlook for the metal is positive.

Historically, gold prices have only moved up during a sustained uptrend in US rates. This is against the common perception that as rates go up, non-interest bearing investments such as gold may lose sheen. Much of the selling in gold is done while waiting for rate hikes and when rates actually move up, the metal also rallies higher.

BusinessLine indicated this in an article in December 2015 (‘Gold braced for Fed rate hike’ - http://premium.thehindubusinessline.com/portfolio/real-assets/gold-braced-for-fed-rate-hike/article7983499.ece ) and this time again, the trend has played out as expected. Since end-2015, after four rate hikes of 25 basis points each by the Federal Reserve, gold is up 20 per cent.

As interest rates rise, there is higher economic uncertainty, which pushes up gold prices.

One more rate hike is expected in December from the Federal Reserve and the up-cycle is likely to continue in 2018.

A recovery in the US economy, which can stoke the US dollar, is a risk to the upside in gold. But that said, if the ECB too starts to shrink its balance sheet and Bank of England announces a rate hike, the euro may go up vis-a-vis dollar. The weak greenback may then make gold attractive and push the price of the yellow metal higher.

If you are an equity investor, we suggest you diversify your portfolio with 10-15 per cent investment in gold. Given that equities are overpriced now, some investment in gold can safeguard your portfolio.

Sovereign gold bond For Indian investors eyeing gold this Samvat, there is a new tool to consider — the revamped sovereign gold bonds.

The 2017-18 Series-III of sovereign gold bonds that opened last Monday (October 9) has a few new features that make it the best option for investors looking to buy gold now.

First, while all previous issues were open for a limited period of about a week, this issue is open till December. The scheme is open for subscription between Monday and Wednesday of every week and the bond will be issued on the first working day of the subsequent week.

Second, the maximum amount of investment allowed in the bond has been increased from 500 gm to 4 kg in a year (April-to-March) for an individual (including investments made through the secondary market in the bond).

Third, there is a discount of ₹50 per gm on the issue price to investors applying online and making the payment digitally. The issue price will be announced every week (available on the RBI’s website). The coupon on the bond remains the same at 2.5 per cent per annum. This will be paid semi-annually and will be calculated on the nominal value of the bond. The tenor of the bond too remains the same at eight years and as in the previous tranches, this time too, premature exit of the bond is allowed from the fifth year. Redemption of the bond will be at the market price (average of last three days) as on the date of maturity.

For both investors and consumers of gold, this bond is an ideal tool.

The cost of investment is lower compared to a coin/bar purchased in the physical market which involves making charges and cost of safekeeping in a vault. It also scores over gold ETFs where there is fund management charge. The advantage for an investor is that this bond is as good as holding the metal in physical form. If gold price rallies during the tenor of the bond, you can benefit from the price gain and if gold price falls, the amount you will get on redemption can buy you the same quantity of gold.

The promise of liquidity is an added attraction of sovereign gold bonds. They are listed on stock exchanges within a fortnight of the issuance. Further, though the tenor of the bond is eight years, premature exit is allowed from the fifth year.

Sovereign gold bonds can be purchased from banks, the Stock Holding Corporation of India, designated post offices and also the National Stock Exchange of India and Bombay Stock Exchange. Investors are required to do the KYC documentation.

Interest on the bonds is taxable as per the provisions of the Income Tax Act. Capital gains on redemption of the bond (if held till maturity) are exempt from tax.

MCX Gold Option There is now a low-cost way to hedge against the price risk in gold. Following SEBI’s nod to launch commodity options a few months back, MCX — the country’s largest commodity bourse — is launching options on gold on Dhanteras, October 17.

The underlying of this contract will be the exchange’s gold futures contract. The attraction with this new derivative tool is that it will not be subject to daily margin calls as in the case of a futures contract. Further, the buyer of an options contract will pay only a one-time fee (premium). The risk of loss is limited to the ‘premium’ as an ‘options’ buyer has the right but not the obligation to buy or sell.

The option contract to be launched will be a European Style contract where the buyer of the option can exercise his option only on the date of expiration of the contract.

Let us take the example of a jeweller here and explain how the options contract can protect him against falling price:

Say, you, as a jeweller, have a stock of gold jewellery purchased at ₹30,000 per 10 gm and fear price falling in the next one month.

To manage this risk, you can buy a gold put option at the strike price of ₹30,000. Let us assume the premium for this contract is ₹300 per 10 gm and you pay it.

Now, one month later at the time of expiry of the contract, if gold prices have fallen to ₹29,000 (market price of the underlying), you will make a profit of ₹1,000 (net of the premium paid for the option, the profit will be ₹700).

This profit will negate the loss in value of your gold stock. Since this option’s underlying is the gold futures contract, on expiry date, it will convert to a futures contract. If you do not intend to deliver, you can square up the position immediately.

If, however, gold prices rise over one month, you can ignore your open position in the options contract. Your loss will be only the premium you paid on the options contract, which is ₹300.

How much gold can one hold in India?

Indian’s love for gold is known. But make sure you buy all your gold from tax-paid income.

Since last November the government has been on a drive to unearth black money, and it makes sense to know the law of land with respect to the holdings in gold of individuals.

The Central Board of Direct Taxes clarified the provisions in the Income Tax Act with respect to gold jewellery through a press release in December last year. It stated that “there is no limit on holding of gold jewellery or ornaments by anybody provided it is acquired from explained sources of income including inheritance. Jewellery and ornaments to the extent of 500 gm for married lady, 250 gm for unmarried lady and 100 gm for male member will not be seized, even if prima facie, it does not seem to be matching with the income record of the assessee.”

The law also provides some leeway to the search officer, where he may choose not to confiscate gold jewellery exceeding the specified limits, depending on the customs and traditions of the family to which the individual belongs, it added.

The gold you inherited from your mother or your grandmother will also not put you into problem, say tax experts.

But how does one prove that the gold is inherited? Tapati Ghose, Partner, Deloitte Haskins & Sells, says, “wealth tax return(s) until 2014-15 for the inherited gold, a will which states that the gold is inherited or a gift deed if the same was executed or even photographs of the jewellery worn by the ancestors and in case of remade jewellery, copy of the receipts issued by the goldsmith or the jeweller,” are some ways.

However, if it is your gold , you should be able to shows the bills, if the search officer asks for it.

You need to also note that if your taxable income is in excess of ₹50 lakh, while filing tax return you need to disclose all assets, including gold.

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