[Economy] Gold Exchange Traded Funds (ETF), Gold Deposit scheme, Elasticity of Demand explained

Economy56 Comments

India Yearbook
  1. Gold deposit scheme (1999)
  2. Gold Exchange traded fund (2006)
    1. What is exchange traded funds?
    2. How does ETF work?
    3. How does Gold ETF work?
    4. Gold ETF: Pros
    5. Gold ETF: Cons
  3. Linking Gold ETF with Gold Deposit Scheme (2013)
  4. Gold deposit scheme (2013)
  5. Gold =Inelastic?
    1. Elasticity of demand
    2. Giffen goods
    3. Normal, inferior goods
  6. Gold: import-export destinations
  7. Mock Questions

Gold deposit scheme (1999)

  • 1999: Government launched this scheme.
  • Under this scheme, an individual/ religious trust can deposit gold (bar, coins, jewelry) to the bank and earn interest on it.
  • Then, bank will convert such gold into gold bars and lend it to gems and jewelry industry (so they can use it for manufacturing).
  • Thus Jewelers have to import less gold = less trade deficit = less Current Account Deficit.
  • And the gold that was earlier sitting idle with public, now gets used for productive purpose.
  • In the end of maturity, you (gold depositor) get two options
    • Get back your gold. But don’t get your “original jewelry” back. Bank will give you gold bar of equivalent weight. (because they’ve melted your jewelry and gave it to the jeweler)
    • Get cash equivalent to the ongoing gold rates.

Cons: Gold deposit scheme (1999)

  • Such gold deposit scheme, require you to deposit minimum 200-500gm gold for minimum 3 years’ period. (Although recently the minimum amount and maturity period was reduced.)
  • Meaning, “target audience” for such gold schemes = religious organizations, temples, trusts that get lot of gold in terms of “donation/charity”.
  • A normal household doesn’t have that much gold!
  • This scheme secretly encourages people to buy gold! (and then deposit in the bank under the given scheme to earn interest).
  • Thus, Government’s original objective (that we need to decrease gold consumption) = defeated.

Gold Exchange traded fund (2006)

Before going into Gold Exchange traded funds (Gold-ETF),

What is exchange traded funds?

  • Exchange traded Fund (ETF)= mixture/hybrid of Mutual fund + Shares
Like mutual fundLike shares
they contains set of shares or commodity (gold, silver.)they can be traded (bought and sold) @stock exchange.

How does ETF work?

  • You already know How mutual funds work. First we (normal/small time investors) give money to the Mutual fund. Mutual fund is managed by an AMC (Asset Management company.)
  • They invest your money in variety of securities>> make profit>> redistributes it among the investors (and earn commission in between).
  • Thus Mutual fund = Investors <–>Mutual fund manager (AMC) <–>sharemarket.
  • In case of ETF, the structure will look like this:
  • AMC<–>authorized participants <–> Share-market <—>Investor.
  • First, the “authorized participants” will deposit gold / shares with the Asset Management company (AMC).
  • The Asset Management company gives them “Creation units”.
  • Each “Creation unit” is contains set of ETFs (5, 10, 50, 1000 depending on their arrangement).
  • These ETFs are then sold to small investors and traded @stock exchange.

How does Gold ETF work?

  • In case of Gold ETF, the authorized participant will give GOLD instead of shares to that Asset Management company. (AMC)
  • Then AMC will give “Creation units” to that Authorized participant. Each creation unit contains set of ETFs (5,10,50,1000 whatever).
  • But 1 unit of ETF = 1 gm gold.
  • Then such gold ETF is traded @stock exchange.
  • 2006: SEBI allowed Gold ETF schemes.
  • Examples of gold ETF= UTI gold ETF, SBI gold ETF, Kotak Gold ETF etc.

Gold ETF: Pros

  • When you invest in Gold ETF, the gold is virtually saved in your DEMAT account = no tension of theft / robbery. And you don’t have to pay wealth tax on it.
  • Gold ETF is pure in quality. No tension of cheating from jeweler.
  • If you buy gold jewelry as “investment” and during emergency you want to sell it, you may not find the buyer quickly (or the jeweler may try to rip you off by giving lower price given you desperation for money.)
  • But in case of Gold ETF, you can sell it quickly, no questions asked, as long as stock market is open. You can even do it online.

Gold ETF: Cons

  • To purchase Gold-ETF, you (small investor) have to pay Commission to the share broker. Although the brokerage on Gold-EFT is less than the Commission charged by conventional mutual funds (MF).
  • You need DEMAT account to purchase Gold ETF. And to open DEMAT account, you need to pay regular fees + need PAN card.
  • To get maximum profit in Gold-EFT, You need working knowledge of share market.
  • In Gold ETF, you never get possession of actual / physical yellow colored gold. What you get is just virtual gold / piece of paper, that can be traded in share-market.
  • Given these reasons, Gold ETF = doesn’t attract investors from small towns and villages. (lack of awareness, fear of unknown etc.)
  • Therefore, gold ETF hasn’t been able to drastically reduce gold consumption in India.

Linking Gold ETF with Gold Deposit Scheme (2013)

  • So far we know that
  1. in Gold ETF, the mutual fund (asset Management company / AMC) gets possession of gold.
  2. in case of gold deposit scheme (1999), you deposit your gold to bank, bank sells/lends it to jeweler. You earn interest and at the end of maturity, you can claim you gold back (but in different form e.g. instead of jewelry, bank will give you gold-bar).
  • Under this “linking” scheme, the Mutual funds are allowed to deposit their gold (under Gold EFT) to the banks (under Gold deposit scheme).
  • Thus, gold held by Mutual funds will come back in ‘circulation’, and our jewelers can use it=it’ll reduce the gold imports of gems / jewelry industry= less trade deficit = less current account deficit.

Gold deposit scheme (2013)

  • Given the cons / limitations of the existing gold deposit scheme (1999) and Gold EFT (2006), Chindu came up with this new idea, in Feb 2013.
  • This new gold deposit scheme (2013) will be operated by Post office (in rural areas) and public sector banks.
  • The concept is similar to fixed deposit scheme.
  • You deposit money to the bank / post office, and they will give you a gold deposit receipt.
  • After end of fixed time (maturity), you give the receipt to bank and you’ll be given options
  1. either get possession of gold
  2. Take away cash (prevailing gold rates at that time).
  3. Convert the gold deposit into fixed deposit (cash) and get interest rates (like in usual fixed deposit schemes).
  • Plus benefits in tax (capital gains, income tax).

Apart from these measures, Government also raised the import duty on gold and platinum from 4 per cent to 6 per cent (in January 2013), to decrease the gold consumption.
A related topic:

Gold =Inelastic?

Elasticity of demand

  • The demand for a product moves in opposite direction of its price.
  • E.g. if price of product increases then its demand should decrease.
  • In other words, demand for good is negatively related to the price of a good.
  • However, the impact of price change is not always the same on demand. For example, in some cases, even if price increases, the demand will not fall down drastically, in other cases it’ll do.

Formula?

  • Elasticity is measured by following formula
  • ED=(%change in demand of a good / %change in price of that good)
  • ED is a pure number. (Because it is a ratio, we’re just dividing two percentages). It doesn’t depend on the units in which price and quantity are measured.
  • ED is a negative number. For example, if the price increases by 5% and quantity demanded decreases by 5%, then the elasticity at the initial price and quantity = −5%/5% = −1
  • But for determining the elasticity, we use the absolute value |ED|
Demand of a goods/service/productWhen?ImpliesExample?
InelasticPrice of product increases by x%, still demand of product doesn’t decrease by x%. (It decreases by less than x%)|ED|<1
  • Insulin injection and other lifesaving drugs.
ElasticIf price of product increases by x%, then demand for product decreases by more than x%.|ED|>1
  • Spa, Tourist resorts, cars and other luxury stuff.
  • Common sense suggest that if price of gold increases then its consumption or demand should decrease, right? But if we look at the import data, that is not happening. Gold consumption hasn’t decreased much despite the price rise.
  • It implies that investment in gold is becoming price inelastic.

Some other concepts regarding elasticity

  • Food is as such “inelastic” in demand. (After all, whether you like it or not, you’ll have to eat!)
  • But specific food item may be elastic, IF close substitutes are available.
  • For example, if ghee becomes too expensive, people might start using vegetable / Dalda ghee. Similarly, butter to margarine.
  • Meaning, if close substitutes are available easily, then demand for a good is likely to be elastic.
  • And, if close substitutes are not available easily, then demand for a good is likely to be inelastic. (for example, again insulin injections and other lifesaving drugs).
  • Food for thought: How do you connect food adulteration and piracy with the elasticity of demand?

Giffen goods

  • So far, We know that when the price of an item increases, its demand should decrease.
  • But there can be a situation when even after price rise, the demand increases!
  • Such goods are called Giffen goods.
  • They violate the general law of supply and demand.
  • This concept was first identified by a statistician, Robert Giffen.

 

Normal, inferior goods
Relation between income and demand?Example?
Normal goods
  • When your income increases, you buy (demand) more quantity of these goods.
  • When your income decreases, you buy (demand) less quantity of these goods
  • For normal goods, as income increases, demand curve shifts rightwards
  • Pure ghee,
  • Ice-cream,
  • Pizza
  • Bournvita, Horlicks
  • basmati rice
Inferior goods
  • When your income increases, you buy (demand) less quantity of these goods.
  • When your income decreases, you buy (demand) more quantity of these goods
  • For inferior goods, as income increases, the demand curve shifts leftwards
  • Dalda (Vegetable) ghee.
  • Coarse rice (instead of Basmati).
  • Used car, mobiles (instead of brand new)

Gold: import-export destinations

  • As per Mines ministry of India, our domestic gold production is barely 2.8 tonnes= not even 1% of our gold consumption can be met by this “desi” gold. Therefore we’ve to import so much “Videshi” (foreign) gold.
Main gold suppliers to IndiaIndian Jewellry mainly exported to
  1. Switzerland
  2. UAE
  3. S.Africa
  1. UAE
  2. Hong Kong
  3. USA.

^this data is from Economic Survey, Ch.7.

Mock Questions

  1. Gold Exchange traded Funds
    1. are regulated by SEBI
    2. requires DEMAT account
    3. Can be traded at stock exchange
    4. All of above
  2. Gold Exchange traded Funds involves
    1. Asset Management company (AMC)
    2. authorized participants
    3. both
    4. none
  3. In 2013, Government allowed linking between Gold EFT and Gold deposit scheme. This will _________ the current account deficit.
    1. Increase
    2. Decrease
    3. Not affect
    4. Worsen
  4. Gold Exchange traded funds contain mixed characteristics of
    1. Mutual fund and shares
    2. Shares and bonds
    3. Mutual funds and ADR
    4. None of above
  5. Excessive gold import by a country like India,
    1. Increases its trade deficit
    2. Increases its current account deficit
    3. Both
    4. None
  6. If A=percentage change in price of a good and B=percentage change in the demand of that good, Then Elasticity of Demand will be
    1. A/B
    2. B/A
    3. A x B
    4. None of Above
  7. Demand of a product is inelastic IF,
    1. demand doesn’t increase despite increase in supply
    2. demand increases more than the supply
    3. Percentage change in demand of a good is less than the percentage change in price of that good.
    4. None of above.
  8. Demand of a product is elastic IF,
    1. Percentage change in demand of a good is less than the percentage change in price of that good.
    2. Percentage change in demand of a good is more than the percentage change in price of that good.
    3. demand increases despite increase in supply
    4. None of above.
  9. In economics, the definition of normal and inferior goods revolves around
    1. supply and demand of good
    2. quality and quantity of good
    3. consumer income and demand of good
    4. none of above
  10. the definition of elasticity and inelasticity in the demand of goods revolves around
    1. change supply and demand of good
    2. change in demand and price of good
    3. change in income of consumer and demand of good
    4. none of above
  11. In economics, inferior goods mean
    1. Those imported from China
    2. adulterated, fake or spurious products
    3. Those goods, whose demand decreases with the rise in consumer’s income.
    4. None of above.
  12. When quantity demanded rises as incomes rise, the said good is
    1. Normal
    2. inferior
    3. elastic
    4. none of above
  13. Griffen goods means
    1. Those goods whose consumption increases with increase in their price
    2. Those goods that observe the law of supply and demand
    3. Goods that are both elastic and inelastic in demand in different countries at the same time.
    4. None of above
  14. If 2% increase in gold price, brings 3% decrease in its demand, then demand of gold is said to be
    1. Elastic
    2. Inelastic
    3. Griffen
    4. None of above
  15. The major source countries for import of gold include
    1. UAE
    2. S.Africa
    3. Switzerland
    4. All of above

Mrunal recommends

  1. (free) NCERT, NIOS, TN-Books
  2. Environment by ShankarIAS
  3. Indian Polity M.Laxmikanth (Hindi | English)
  4. Art & Culture by Nitin Singhania (Hindi | English)
  5. Spectrum: Modern History (Hindi | English)
  6. Bipin Chandra: Post Independence
  7. Fast-track to Arithmetic Rajesh Verma
  8. MK Pandey’s Analytical Reasoning
  9. Disha’s Topicwise Paperset (Hindi | English)
  10. School Atlas
  11. Mains: Language papers
  1. (free) NCERT, NIOS, TN-Books 4 History,Geo,Sci
  2. Indian Polity M.Laxmikanth (Hindi | English)
  3. Spectrum: Modern History (Hindi | English)
  4. Maths: Quantam CAT Sarvesh Kumar
  5. Objective General English SP Bakshi
  6. Word Power made Easy -Norman Lowe
  7. Topic wise Solved Paperset by Disha


So far 56 Comments posted

  1. bhaz

    there is 1 more gold investment option called e-gold

    here is some info regarding it

    e-Gold
    • another purchase option, involving investments in units traded on the National Spot Exchange (NSEL)
    • e-Gold’s brokerage and transaction charges are lower than gold ETFs as there are no fund management charges
    • investor is required to have a demat account with an affiliate of NSEL
    • One can take delivery of gold or sell it in the exchange.
    negative point

    Under e-Gold, one has to hold the yellow metal for 36 months to enjoy long-term capital gain benefits,

    1. TRA

      (add on to above)
      eGold vs gold ETF

      -Under e-Gold, one has to hold the yellow metal for 36 months to enjoy long-term capital gain benefits,
      which is taxed at 20 percent after indexation
      -for ETF and gold funds, holding period to be classified as long term is only 1 year.
      -after 1 year etf and gold fund will suffer 10 percent tax without indexation and 20 percent after indexation.

      -for a small investor,gold ETF would appear to be the best option, as it meets his need without difficulties in terms of creating a separate demat account ,tax implications and wealth tax.

      1. aspirant

        Gold etf requires compulsorily demat account…..
        So investor needs to have a demat account…but yes he is exempted from wealth tax

    2. RKS

      Just to add –

      Gold ETF can be converted to Physical Gold given that the conversion is for 1000 Units ie. for 1kg gold in most of the cases.

      But, there are some ETF schemes of other house like Motilal Oswal which allows for conversion for 10 or 100 Units i.e 10 gms or 100 gms.

      Regards

  2. puneet

    hei mrunal
    Is this a blank article or some technical fault, only comment of BHAZ is seen by clicking on this article..Please rectify it.
    regards
    puneet

  3. puneet

    ok..problem solved.. 🙂

  4. swapnil pandey

    1.D
    2.C
    3.B
    4.A
    5.C
    6.B
    7.C
    8.B
    9.C
    10.B
    11.C
    12.A
    13.A
    14.A
    15.D

  5. swapnil pandey

    IF ANY CORRECTION REQUIRED PLS DO IT..?

  6. Tenzing

    Hi Mr. Mrunal As soon as I click on your link for the whole article, I am unable to see the main article..only comments page are being shown.Please help me to get to the main article.Thanks.

  7. Mrunal

    @Above friends,
    There was some issue with the PHP code. I’ve fixed it. I hope pages are displaying properly now.
    Inconvenience is regretted.

  8. TRA

    thanks sir
    1.d
    2.c
    3.b
    4.a
    5.c
    6.b
    7.c
    8.b
    9.c
    10.b
    11.c
    12.a
    13.a
    14.a
    15.d

      1. Nikhil

        I think in question 7 and 8 we are preassuming that demand will always go down as the prices are increased (which is not the case with griffen goods as explained in the article)…as in …in ques 8 the stmt says that “Percentage change in demand of a good is more than the percentage change in price of that good.”…now the “Percentage” change in demand of griffen goods will be positive with increase in prices and even for some normal goods it can be zero if not positive… in that case i guess the demand will be inelastic instead of elastic because the demand is increasing (or is constant) even when the prices have increased and the rate of change of “INCREASE” of demand is less than rate of change of increase in price..

  9. puneet

    answers:
    1.d
    2.c
    3.b
    4.a
    5.Well it depends..if the country(like switzerland) is self sufficient in gold resource dan neither of the option.
    6.b
    7.c
    8.b
    9.c
    10.b
    11.c
    12.a
    13.a
    14.a
    15.d

    1. Hamed

      it’s clearly mentioned india.

  10. HK

    1.d
    2.c
    3.b
    4.a
    5.—
    6.b
    7.c
    8.a
    9.c
    10.b
    11.c
    12.a
    13.a
    14.a
    15.d

  11. Garima Sharma

    Nice article….

  12. Suresh

    1.d
    2.c
    3.b
    4.a
    5.c
    6.b
    7.c
    8.b
    9.c
    10.b
    11.c
    12.a
    13.a
    14.a
    15.d

  13. love shandilya

    can anybody explain what is civilian employees of defence forces??

  14. Bharat

    Jai ho Mrunal !! Kitne Simple Lang me xplain karte ho 🙂

  15. Ratatouille

    Interesting!! Sir: writing style & your responses have become elaborate!Thnx!

  16. SAHIL

    1.D
    2.C
    3.B
    4.A
    5.C
    6.B
    7.C
    8.B
    9.C
    10.B
    11.C
    12.A
    13.A
    14.A
    15.D
    THANK U SO MUCH MRUNAL SIR.
    PLS GIVE A ELABORATIVE ARTICLE ON ENVIRONMENT AS SOON AS POSSIBLE.

  17. karan

    guys one doubt,

    If money is invested in Gold ETFs then can we say the money is directly increasing the liquidity in the economy?

    Can this be in any way linked with inflationary changes in the economic system?

    1. Hamed

      In my opinion, yes. We import less, diverting funds from unproductive purpose to productive use, less burden on BoP, indirectly reduces CAD, thereby maintains stability in currency, less impact on crude import. Thus, stability in the economy is maintained. Iflation thus contained.

  18. Nikunj

    Thanks Mrunal,

    I was waiting for an article about Gold ETFs as it was recently in news. I tried to refer to investopedia.com and wikipedia but understood with limited success.

  19. shubha

    Thank you sir for making economics easy n fun to understand,
    can you please show the graph for rightward and leftward shift in the demand curve.

    1. Hamed

      Rightward shift means downward slope towards ur right above the existing slope. And leftward shift means downward slope towards ur left below the existing slope. Hope it helps u understand something.

  20. shashi

    Namaste Mrunal sir,
    I always follow ur blog,you write an article in such a way that it understand very easily..
    thank you so much…sir

  21. mr einstein

    sir, can u plz write on the kosovo-serbia conflict and the recent deal between them…

  22. Mazhar

    Thank you Mrunal….

  23. himanshu

    Elasticity is defined as relative ratio of % change in demand of good to %change in price of good.
    We have learnt that in case close substitutes of a food product (for instance) are not available, no matter what the price of that food product is, demand for the product does not subside considerably.
    Ex. If Milk went from 20/L to 40/L, people’s consumption did not decrease by 100% , while the price did increase by 100%.
    Considering food adulteration, piracy, both of these practices aim to provide cheaper generic less qualified version of pure food products to have price of these mix quality (often less quality) food products REDUCED, which in turns sets various alternatives close to food product in concern, hence making demand-price relation of that product ELASTIC. This BOOSTS the demand for such product; hence utilizing economies of scale principle, these adulterations, and piracy performing companies reap big profits.
    Mrunal – Please let me know if my response assesses the relation in the right direction.

  24. Misfit Medico

    @ Friends who are following Mrunal Sir’s Blog religiously

    Is there anyone who has compiled PDF or Word of all economy articles as well as other sections ?

    I have started to make lately.
    If any one has already made the collection, Kindly share it here or through mail.

    If not, then I think we among ourselves will share the responsibility to
    make compilation on each topic,
    Like,
    Economy
    E & B
    Science and Tech etc…

    Kindly revert with inputs..

    P.S. @ Mrunal Sir,Are you listening ?
    Well, we are already obliged by your effort and in deeply in debt, but If you have
    then we would like to have a glimpse at such dropbox folder.

  25. sam

    can anyone explain clearly what does “authorized participants” and “Creation units” mean,here??????plzzzzzzzz

  26. GIRIDHARAN

    You deposit money to the bank / post office, and they will give you a gold deposit receipt. we have to deposit MONEY or GOLD??

  27. phani

    awesome sir….

  28. Sun

    Can any one please guide me how to download it in PDF?I have installed Crome but i am not able to proceed.

    Sun

    Thanks in advance

  29. Vikas Tomar

    Answer Keys….

    d c b a c b c b c c c a a a d

    Please confirm iff any of them is wrong….!

  30. Shubham Gupta

    sir, how can it be possible that the euation Ed= (% change in demand/% change in price) yeild value greater than 1 in case od elesticity..
    i mean to say if price of any thing increased by 5 % and thus its consumption decrease by 4 % then |(-4/5)| will be equal to .8 that is always less than 1, as the price acc to you is always greater than the % change in the consumption…
    please took a note.. if m wrong then do correct me..

    1. Nik

      Mr. Gupta,

      It is no where mentioned in the article that “price is always greater than the %age change in the consumption”

      Price Elasticity of Demand has three dimensions:-
      1. Demand is elastic, when “%age change in demand is > %age change in price”. The elastic coefficient is will always be greater than 1

      2. Demand is unitary elastic, when “%age change in demand is = %age change in price”. The elastic coefficient is will always equal to 1

      3. Demand is inelastic, when “%age change in demand is < %age change in price". The elastic coefficient is will always be lesser than 1

      One more thing "it is the demand which is said to be elastic, unitary elastic or inelastic" and not the price

  31. preetham

    SIR…..u r ultimate….

  32. Akram

    d c b a c b c b c b c a a a d

  33. Siri

    cess on service tax goes to centre or is shared b/w Centre and states?

  34. Ashwin

    why india import so much gold if it resulting in Current account deficient it should either stop importing or impose very heavy tax on gold and make security vigilant so that no smuggling take place.
    And one more thing if people buy gold from their own pocket why is india suffering from CAD .

    1. karthik

      @ashwin….its easier said than done……controlling smuggling is not possible…..hence can’t impose heavy tax.
      Secondly, customers don’t buy gold from abroad…..coz of domestic demand….dealers import gold (like a company import sum xyz machine)to sell in domestic market nd now luk at it this way —-to import anythng one needs dollars…..so india export to earn dollars then use these dollars to import

  35. keerti

    PLEASE explain ‘Creation units’ and ‘set of ETS’.. PLEASE.. i dint get anything:(

    1. Hamed

      1 unit of ETF = 1 gm gold. Creation unit is a set of ETF which may be in units of 5/10/50/100/so on..of ETFs depending on the arrangement.

  36. Hamed

    Hello mrunal sir, could u pls xplain authorised participants? Who are authorised participants? And in linked gold ETF scheme, does the investors gets interest income as they get in Gold deposit scheme?
    I ll be happy if anybody xplains… 🙂

  37. asp

    In the “Cons: Gold deposit scheme (1999)” section, isn’t there inherent meaning tht the price of gold bar for the same weight of jewellery will be much less. The buyer of Gold deposit scheme (1999) looses on the amount he/she paid for the service(manufacturing) of that jewellery.

    In other words… is price of 1kg of gold bar < (less than) 1kg of jewellery??

    please correct me, if m wrong..

  38. Fixed Deposit

    Fixed deposits (FD) are one of the best ideal investment tools in India. Fixeddepositbazaar is leading financial information source which provide services such as a Fixed Deposits, Bonds, and Debentures etc.

  39. arvind dang

    Scheme 2013 gold deposit
    dmat is required or not?

  40. Jagan

    UAE is listed as one of the largest importer as well as exporter of gold from/to India respectively .. If India is importing large quantity of gold from UAE, then what is the point in exporting the following to UAE again ?

    1. Blue

      The gold is exported in the form of jewellery as the finished product. India has expertise and skilled manpower in gold products/ other jewelries.

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