Gold and Silver ETFs: With precious metals especially gold and silver, remaining in the spotlight over the past few months, Gold and Silver exchange traded funds (ETFs) have emerged as preferred investment plays for long as well as short term investors.
Before delving deeper into Gold and Silver ETFs, it is important to understand what an ETF is. An ETF is an investment fund that can be bought and sold on the stock market just like a share. It pools money from multiple investors and invests in a basket of assets such as equities, bonds, commodities like gold and silver, or market indices such as the Nifty 50 or Sensex. The price of an ETF fluctuates during market hours in line with the value of its underlying assets.
With that clarity, Gold and Silver ETFs can be better understood. These ETFs allow investors to invest in gold or silver without the hassle of physical purchase or storage of the metals.
A Gold ETF tracks the price of physical gold, with each unit typically representing a fixed quantity, such as 1 gram. The fund house holds an equivalent amount of physical gold in secure vaults, and the ETF’s price closely mirrors movements in gold prices. Investors can buy and sell Gold ETF units on stock exchanges during regular trading hours.
Silver ETFs operate on a similar mechanism but track the price of silver instead. They enable investors to benefit from fluctuations in silver prices while eliminating concerns related to storage, purity, and safety.
ETFs are commonly used for portfolio diversification, as a hedge against inflation, and as a defensive allocation during periods of market volatility. Additionally, unlike jewellery purchases, these do not involve making charges and are regulated instruments traded on recognised exchanges.
In recent times, demand for both Gold and Silver ETFs increased sharply following the strong rally in precious metal prices in January. Although prices corrected in early February, investor interest in these instruments has continued to remain firm.
However, before allocating money, investors need to clearly understand how these ETFs work, how they are taxed, and what risks they carry. Here are five critical aspects every investor must evaluate before investing in Gold and Silver ETFs.
5 key things to know
1. Taxation: Taxation is one of the most important — and often misunderstood — aspects of Gold and Silver ETFs. As per current Indian tax rules, Gold and Silver ETFs are treated as debt-oriented investments. This means that capital gains from these ETFs are taxed according to the investor’s income tax slab rate, irrespective of the holding period. The earlier benefit of long-term capital gains with indexation no longer applies.
As a result, gains from Gold or Silver ETFs are added to taxable income and taxed at slab rates, which can go up to 30% plus cess for high-income investors.
2. Expense ratio: Every Gold and Silver ETF charges an expense ratio, which covers fund management, custody, marketing and operational costs. While these costs may look small on paper, they compound over time and can eat into returns. Typically, expense ratios for precious metal ETFs range between 0.3% and 1% annually, depending on the fund house and scale of assets.
Unlike equities, gold and silver do not generate earnings or cash flows. Therefore, returns are entirely price-driven. This makes cost efficiency even more critical. Over a long holding period, a higher expense ratio can create a noticeable drag on performance, especially during phases when metal prices move sideways. Comparing expense ratios across ETFs is essential before making a selection.
3. Price volatility and market risks: Although gold is often viewed as a safe-haven asset, both gold and silver prices can be highly volatile in the short to medium term. Prices are influenced by multiple global factors such as interest rates, inflation expectations, currency movements, geopolitical tensions and central bank policies. Silver carries an added layer of volatility because of its significant industrial usage.
Gold and Silver ETFs mirror the price movement of the underlying metal and offer no downside protection. Sharp corrections can occur during periods of rising interest rates or strengthening global currencies. Investors should be prepared for price swings and avoid treating these ETFs as low-risk or capital-protected instruments.
4. Tracking error: Tracking error refers to the difference between the ETF’s return and the actual price movement of gold or silver. This can arise due to expenses, cash holdings, operational inefficiencies or timing mismatches. Over time, a consistently high tracking error can reduce the effectiveness of the ETF as a true proxy for bullion prices.
Liquidity is another key factor. While most large Gold ETFs are fairly liquid, Silver ETFs can sometimes witness lower trading volumes. Lower liquidity can lead to wider bid-ask spreads, increasing transaction costs for investors. Checking average daily volumes and assets under management helps ensure smoother entry and exit without price distortion.
5. Portfolio role: Gold and Silver ETFs are best used as diversification tools rather than return-maximising instruments. Historically, precious metals have shown low correlation with equities and fixed income, making them useful for reducing overall portfolio volatility. However, they should not form a disproportionately large portion of the portfolio.
Most financial advisors recommend keeping precious metals exposure within 5% to 10% of total portfolio value, depending on risk appetite and investment horizon. Over-allocating based on short-term price momentum can backfire, especially during prolonged consolidation or correction phases. Investors should view Gold and Silver ETFs as long-term stabilisers rather than tactical trading bets.
In conclusion, Gold and Silver ETFs offer a convenient way to participate in precious metals, but they come with specific tax implications, costs and risks that investors cannot ignore. Understanding taxation, expense ratios, volatility, tracking efficiency and portfolio role is crucial before investing. A well-informed allocation, aligned with long-term financial goals, can help investors use these ETFs effectively without unpleasant surprises later.
