Gold Exchange-Traded Funds (ETFs) have emerged as one of the preferred instruments for retail investors seeking to allocate their capital to the yellow metal. AMFI data show that the investor accounts in gold ETF increased from a mere five lakh in January 2020 to 65 lakh by January 2025. Rising geopolitical tensions, shifts in central bank policies, and equity market volatility have collectively fuelled the gold rush.
While buying the units of gold ETFs on the exchanges, investors need to ensure that they buy at an appropriate price. Key factors to consider when purchasing gold ETF units in the secondary market include high liquidity, low tracking error, and minimal impact cost. Additionally, investors should assess whether the trading price of the gold ETF units is close to their fair value. Due to various reasons, the trading price of the ETF units may trade at either premium or discount to their Net Asset Value (NAV) value which can significantly affect your returns.
Market price vs NAV
ETFs trade on stock exchanges and have two end-of-day values: the closing market price and the NAV. Simply put, the closing market price is the last traded price during the day on the exchanges. On the other hand, the NAV calculated by the fund house after the market closes, is the average value of the ETF’s holdings, minus expenses, divided by the number of units. While the closing price and NAV are often similar, they can differ at times, which is called premium or discount of the price to the NAV.
A premium means the ETF is trading above its NAV, indicating you may be paying more than the actual value of the underlying assets. On the other hand, a discount means the ETF is trading below its NAV, suggesting you could be buying the ETF at a price lower than the value of its assets.
Premiums & discounts
A few factors that drive the premiums and discounts include inactive market makers, illiquidity and volatile market.
Market makers or authorised participants bridge the gap between the market price and the fair value. They are mostly the large investors or brokers who act as an intermediary between the fund houses and the market. If demand for an ETF increases and a premium to NAV develops, market makers step in to create more units and push the ETF’s price in line with the NAV.
If an ETF is being sold heavily and a discount develops, they purchase ETF units in the open market and redeem with the fund house to reduce supply.
In highly volatile markets and during periods of heavy trading activity, market makers may fail to provide the best bid or offer at a given time, leading to significant premiums or discounts. For example, during the Budget announcement on July 23, 2024, the Finance Minister announced a reduction in the basic custom duty on gold, which lowered the overall taxes on gold from approximately 18.5 per cent (including GST) to 9 per cent. While the prices of physical gold dropped significantly during the day, gold ETFs, in contrast, traded at a premium relative to their fair values. Even the most liquid gold ETFs experienced premiums of around 4-5 per cent on their market prices compared to their fair values. If investors had purchased units at this premium, they would have incurred a corresponding percentage loss in returns upon redemption.
Market makers in ETFs are compensated primarily through the creation and redemption process, which allows them to profit from arbitrage opportunities. However, the lack of or limited involvement of market makers in ETFs is a concern in India. It is important to highlight here that the six overseas ETFs in India have traded at substantial premiums to their fair value in the recent months. This has occurred due to the lack of market makers, a situation driven by existing regulatory restrictions.
Indicative NAV
Since NAVs are disclosed at the end of the day or the next morning, they may not accurately reflect real-time market conditions. Instead, you should compare the market price with the indicative NAV (iNAV), which provides a more timely and relevant snapshot of the ETF’s value.
The iNAV of equity ETFs are disclosed at a maximum lag of 15 seconds, and for gold ETFs and debt ETFs, a minimum of four times a day. You can get these numbers from fund house websites.
Premiums and discounts do not always signal ETF inefficiencies but are frequently a result of market conditions and liquidity levels. Monitoring the premium or discount helps investors make informed decisions, ensuring they are not overpaying or missing out on potential value opportunities.
While the Gold ETFs are suitable for investors who want higher liquidity and the ability to trade real-time on the stock exchange, Gold FoF can serve the purpose for the small investors who prefer a simpler investment process without needing a demat account and want to invest through systematic investment plans (SIPs).