Case 086Alternatives and private marketsWarm up
A client wants Rs 1 crore in gold. Compare jewellery with 12% making charges plus tax, a gold ETF and a government gold bond structure on cost and income. What does each route keep of the gold price?
1The situation
The Walawalkar family wants Rs 1 crore of gold as a long-term holding. Their daughter marries in about five years and some of the gold may be worn then. They are weighing three routes and ask you to compare them over five years.
Use illustrative figures and tell them to confirm each: jewellery carries 12% making charges and 3% tax on the gold plus making, and a jeweller buying it back deducts 3% of the gold value and pays nothing for the making; a gold ETF costs 0.5% a year plus about 0.25% to buy and 0.25% to sell; a government gold bond structure is bought at the gold price, pays 2.5% a year interest on the amount invested, and repays the gold price at redemption. Whether new bonds of that kind are being issued, and how each route is taxed, must be confirmed at the time.
2Your task
Which route keeps most of the gold price for this family, and what is the catch in each?
Quick check
With the gold price unchanged for five years, roughly what does Rs 1 crore of jewellery return when sold back?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
The bond structure keeps the most and jewellery the least: about Rs 112.5 lakh, Rs 97.0 lakh and Rs 84.1 lakh back on a flat gold price. Jewellery loses about 16% before the price moves, because making charges and tax are never recovered. The ETF loses a little each year to its expense ratio. The bond structure holds the full gold price and adds 2.5% a year of taxable interest, subject to availability. Buy exposure now and make jewellery only for the wedding.
Step 1Why does the vehicle matter when the gold is the same?
Because each vehicle takes its own cut before and after the gold price does anything. Buying a phone from a shop and selling it back the next day loses the shop's margin even though the phone did not change. Jewellery charges for the craft, which a buyer later will not pay for, so Rs 1 crore buys only about Rs 86.7 lakh of gold and the rest is gone the day it is bought. The comparison that decides this case is how many rupees of gold price each route keeps, not which is gold and which is paper.
Step 2What does each route cost, in rupees?
Work each one on Rs 1 crore. Jewellery: Rs 1 crore divided by 1.12 and by 1.03 is about Rs 86.7 lakh of gold, and a 3% buyback cut leaves about Rs 84.1 lakh. The ETF loses about 0.5% a year to its expense ratioThe annual cost of running a fund, taken daily from its assets, so it shows up only as a slightly lower value. plus two small trading costs, about Rs 3.0 lakh over five years. The bond structure keeps the full gold price and pays Rs 2.5 lakh a year of interest, Rs 12.5 lakh over five years before tax.
| Route | Gold price flat, Rs lakh | Gold up 40%, Rs lakh | Income along the way | The catch |
|---|---|---|---|---|
| Jewellery | 84.1 | 117.7 | None | Making charges never come back |
| Gold ETF | 97.0 | 135.9 | None | Small yearly expense; needs a demat account |
| Gold bond structure | 112.5 | 152.5 | 2.5% a year, taxable | Availability and exit terms must be confirmed |
Step 3What would you say to the family, and what is the limit of the comparison?
Separate the investment from the wedding. Hold the gold exposure in the bond structure if it is available, or an ETF if it is not, and convert only the part that will be worn into jewellery at the wedding, when the designs are chosen. The making charge is then paid once, on jewellery that is used, rather than on a holding. Name the limits: the bond structure's availability, exit terms and tax treatment must be confirmed, it carries the credit of its issuer, and the ETF's tax treatment can change. Jewellery also has a value the table cannot price, which is the family's to judge.
Where candidates lose it
Candidates compare the three on the gold price, which is the same for all of them, and miss the entry and exit costs that decide the answer. Making charges alone take 12 rupees in every 100 before tax.
The second miss is stating the bond's interest rate, tax exemption or availability as current fact. Say it is illustrative and must be confirmed, which is exactly what the interviewer is checking.
What the interviewer asks next
- The family insists on holding physical gold. Is there a cheaper physical route than jewellery?
- How much gold, as a share of the whole portfolio, would you think reasonable for this family?
- What happens to the bond structure's value if gold falls 20% in the year they need the money?
Company names and figures are illustrative.