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

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

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
• E_D=(%change in demand of a good / %change in price of that good)
• E_D 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.
• E_D 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 |E_D|

• 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.

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.

^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