How Gold ETFs work? Creation Units and Gold ETF Units

This article explains the working of gold ETF funds. The following are the major participants in gold ETFs.

ETF sponsor
Authorized Participant
Custodian
Exchange
Retail Investors
Institutional/large investors

ETF sponsorAuthorized ParticipantCustodianExchangeRetain InvestorsInstitutional/large investors

Let’s understand the working of gold ETFs.

A mutual fund sponsor (like HDFC, Quantum), when senses a market for gold ETFs, approaches authorized participants to arrange for required physical gold. If these two comes to an understanding, the fund sponsor (ETF sponsor) files a prospectus with the SEC (in the U.S.)  or SEBI (in India). 

Initial Offer

Once the regulator gives approval, the ETF sponsor collects money from retail investors and gets physical gold through authorized participants and keeps it in the custody of custodians. The ETF sponsor provides ETF units back to the retail investors.

Post NFO

Once the New Fund Offer Period is over, the ETF sponsor doesn’t deal with the retail investors directly. The gold ETF is listed on the exchange and the units are traded just like any other stock.

Gold ETF funds working

Authorized participants, who are market makers, act as intermediaries between retail investors and the gold ETF sponsor through the exchange.

Authorized participants get creation units from the gold ETF sponsor in exchange of physical gold. Creation unit usually comprises of 1000 grams of physical gold and in return the authorized participants get gold ETF units worth the physical gold.

Authorized participants then take care of creating the market by supplying gold ETF units as per the demand. A gold ETF unit usually represents either 1 gram of gold or half gram of gold so that small investors can buy.

The gold ETF sponsor arranges for safe custody of the physical gold. Usually, specialists called custodians do this job for sponsors for a fee. The gold ETF sponsor is responsible for quality of gold, safety of gold. The gold ETF sponsor takes adequate insurance for physical gold. The gold ETF sponsor can also invest in money market instruments upto the percentage mentioned in the offer document.

Be Sociable, Share!
ADVERTISEMENTS

Related posts:

  1. How to Invest in Gold ETFs Online
  2. Gold ETFs list – Gold ETF funds list in India
  3. Best way to Invest in Gold – Gold ETFs
  4. Things to consider before choosing a gold ETF
  5. Comparison of different gold investments- Physical gold Vs Gold on commodity Exchange Vs Gold ETFs

{ 30 comments… read them below or add one }

halavath krishna June 8, 2011 at 5:26 pm

hello sir,
I want to invest in gold etf scheme, will u pls reveal how to open the demat account for purchasing and selling of gold coins?

Reply

Sathish Emmadi June 8, 2011 at 5:33 pm

Hi Krishna,

Please visit the below link for some understanding.
http://www.goldetf-funds.com/how-to-invest-in-gold-etfs-online

Please contact any of the brokerage firms like Kotak securities, Sharekhan, IIFL for opening a demat account. The documents required to open a demat account is listed out at the above URL.

Reply

Sathish Emmadi June 8, 2011 at 5:34 pm

Also please note that demat account with a normal broker is useful for trading only gold etfs not for e-gold, for which you need to open an another account.

Reply

ashima lohia June 20, 2011 at 9:52 am

Do u mean, that if I want to trade in gold certificates or gold MCX , i need to have another type of account, other thanDemat? Please advise on how to trade in gold MCX.

Reply

Sathish Emmadi June 20, 2011 at 4:16 pm

Hi Ashima,
Yes. Demat is a general word for paperless certificates or shares. The brokers need to take trading membership with different exchanges. For commodities they ask for separate docs.

Visit the below two sites for clarity.

http://www.kotaksecurities.com/
http://www.kotakcommodities.com/

Reply

Deepak September 13, 2011 at 12:18 pm

Consider the scenario, what happens if there are only sellers and no buyer for gold ETF. Who will own the physical gold (the one how holds the ETF or someone else).

Is it possible for ETF sponsor to add more gold and issue new ETF, or buy back some ETF and sell some gold.

Are there a chances that value of physical gold hold by sponsor/custodian be different than market value of ETF ( Total # of etf X price per unit). How is this tracked and where?

Who pay the Mgmt fee and custodian fee and from where this money is generated, since NAV/Price of ETF is decided by buyers and seller and there is no role of sponsor once NFO is issued.

Reply

Sathish Emmadi September 20, 2011 at 5:07 pm

Hi Deepak,

All good questions.

1. Market makers (Authorized Participants mentioned in the article) take care of these situations. So no big gap would be there between demand and supply.

2. The fund owns physical gold but is under the custody of the custodian who charge a fee for its services.

3. Yes, authorized participants deal with the fund management to convert gold ETF units.

4. The value can be different because of demand supply gaps. But it doesn’t deviate heavily. The difference is called tracking error.

5. AMC charges authorized participants for all the fees and so it is reflected in the ETF unit price.

Reply

Mukta September 27, 2011 at 6:19 am

Does this means that the the unit price of ETF gold would be costly then the unit price of same gold from open market.
Could you give an example to show me some approx difference in value.

Reply

Sathish Emmadi September 28, 2011 at 4:29 pm

Hi Mukta,

There is a difference in Gold ETF unit price and online gold (commodity trading). But this difference is there when you buy as well as when you sell. So it shouldn’t be a problem.

Reply

Vivek Vatve September 28, 2011 at 5:38 pm

Sir,
Which Gold ETF fund is better as per your view?
Can you give the current NAV’s (as on 28/09/2011) of the existing ETF’s?

-Vivek Vatve
vrvatve@rediffmail.com

Reply

Sathish Emmadi September 29, 2011 at 4:34 pm

Hi Vivek,

Pls take a look at the below link.

http://www.goldetf-funds.com/best-gold-etf-in-india.

Please visit all gold ETF links provided on the site to check the unit price.

Reply

Dsharma October 20, 2011 at 5:19 am

Hi,

I also want to invest in GoldETF but has few questions :

1) If i start investing today and invest for a year. After 2 year I want to withdraw the account, what will I get Physical Gold or monetary amount for the gold?

2) Will I get any tax benefit for this investment?

3)If I get monetary amount, will it be taxable (i guess, it is)? If it is taxable then whether the total amount will be taxable (amount I invested+profit) or only profit will be taxable.

Reply

venkatramaiah October 20, 2011 at 6:08 am

how the selling price of one gram gold is determined in gold etf. whether it is dependent on gold price or on gold etf demand?

Reply

Srikanth Pai December 2, 2011 at 4:57 am

Hello Sir,

I would like to understand how exactly will a gold etf work my way. I did understand the procedure involved but unable to understand in which way is it beneficial to invest in a gold etf. A reply with an example would be preffered for better understanding.

Thank you!

Reply

Sathish Emmadi December 3, 2011 at 2:41 pm

Hi Venkataramaiah,

I would say both. Primarily it depends on the price of gold, that’s why you see the price of gold etf doesn’t deviate too much from the price of gold. The actual deviation can be attributed to demand and supply, Other investments by the fund (gold etfs can invest in money market instruments).

You can find some more info at http://www.goldetf-funds.com/best-gold-etf-in-india

Reply

Sathish Emmadi December 3, 2011 at 2:46 pm

Hi D Sharma,

Please find below answers to your questions.

1.It’s the amount for gold. Physical delivery is not available for investments in Gold ETFs. E-Gold offers that facility which I will cover in detail later.

2. No. Investments in gold ETF doesn’t attract tax benefits. But the return on investment is not taxable if you stay invested for more than an year.

3. Only profit will be taxable if you sell within one year and get profits.

Reply

Sathish Emmadi December 3, 2011 at 2:53 pm

Hi Srikant Pai,

In India you don’t have wide variety of gold ETFs to get benefit out of fluctuations in gold ETF in a big way. The only available way is take a long position in gold ETF (i.e. buy a Gold ETF) if you think price of gold will go up in future and sell it when it actually goes up. If it doesn’t go up as you expected, you will either need to wait until it goes up or book loss to come out of it.

Reply

Amit Jain December 20, 2011 at 7:41 am

hi,
i want to know how good it would be to invest in Gold ETF for long term investment purposes?
Will it yeild at least same growth [or depriciation] as investment in physical goldl considering charges for maintaining both of them.
i will be highly obliged if the reply can also be sent to the email address provided.
Thanks
-Amit Jain

Reply

Sathish Emmadi December 21, 2011 at 5:22 pm

Hi Amit,

The returns may not exactly match, but they are inline with returns on bullion gold. But for most of the investors gold ETFs are definitely a better option when compared to physical gold.

Reply

Copelon J. Kirklin December 23, 2011 at 8:08 pm

I would like to know what type of revenues are earned for the individual/entity who is apart of the inception/launch of the gold ETF. For example, say there is a planned launching with an opportunity for an equity investor to put up funds associated with the launch. What type of revenue can he stand to make from this? Let’s say it’s a $15B ETF and the equity investor is required to put up $5M. I guess it’s a question akin to if someone put up funds and became an equity investor in Google before it went public. Not the exact same thing but similar in concept and question. Thanks in advance!

Reply

Sathish Emmadi December 25, 2011 at 12:48 pm

Copelon,

For a retail investor who invests in the NFO (new fund offer), there won’t be any listing gains unlike stocks. Gold ETF NFOs are similar to normal mutual fund NFOs.

Reply

Copelon J. Kirklin December 27, 2011 at 6:26 pm

Thanks for the response Sathish. But to be more specific, the “retail investor” has bit larger role in the launch of this gold (bullion coins) ETF. It is a JV partnership in setting up a Swiss AG company in which the investor will have a 60% shareholder’s position in the company for the entire launch. The launch will also be backed by one of the top world banks. This should change how the investor is compensated in the traditional sense of a retail investor, being that they’re a shareholder correct?

Reply

Sathish Emmadi December 30, 2011 at 5:35 pm

Hi Copelon,

Yes, retail investors will become share holders. As per my knowledge in a Gold ETF NFO, funds are collected from investors and physical gold is bought from the pooled money.

So the value of a gold ETF unit depends on price of physical gold. So shouldn’t the listing gains be in proportion to the physical gold price movement from the day of purchase by the fund and the day of listing?

Reply

Derik Thomas January 21, 2012 at 1:54 pm

Hi,

I am just starting to learn about ETFs and have a few queries.. How much is the average annual dividend that you can expect from the ETFs? And can I redeem the ETF units in physical gold?

Reply

Sathish Emmadi January 21, 2012 at 4:51 pm

Hi Derik,

Your question is specific to Gold ETFs or in general about ETFs? If it is gold etfs, the returns depend on the gold price movement. If gold appreciates by 20% the returns will be near 20%. If gold depreciates you will need to incur loss around same percentage.

Reply

Gihan from Sri Lanka February 10, 2012 at 7:03 am

all over the world equity markets are come down . Therefore better investment is invest in commodities.
Can i expalin me operation strcture of Gold fund and Gold ETF and any article link

Reply

Sathish Emmadi February 10, 2012 at 4:50 pm

Hi Gihan, This article clearly explains working of Gold ETFs. Do you have any specific questions?

Reply

Dhilip March 21, 2012 at 3:18 am

Hi Currently the prices of SBI gold etf comin down & hangs there 2720 – 2730 .. will the prices decrease again ? what factor affecting the current gold prices decline from 2800?

Reply

kartik April 21, 2012 at 8:26 am

i would like to know, what is the minimum amount is required to invest in goldETF?

Reply

Narendra March 21, 2013 at 5:44 am

Hi,
I have some etf units which i want to convert into physical gold. i do not want to redeem it and use the proceedings in the Gold. this may attract capital gain tax.
Kindly advice.
Narendra

Reply

Leave a Comment

*