All You Need to Know About Sovereign Gold Bonds

Have you felt the need for gold in your investment portfolio? If you have not, you need to think again. Gold is a physical asset, is globally priced and can be a good hedge against high inflation and rupee depreciation. Even though gold is a speculative asset, it deserves a small part in your investment portfolio for diversification purposes. I advise clients to have 5-10% of their investment portfolio in gold. Gold can provide protection to your investment portfolio when the financial markets across the world are in serious turmoil.

If you have decided to invest a portion of assets in gold, how should you invest? There are many ways to invest in gold.

  1. Physical gold or jewellery
  2. Gold Mutual Funds
  3. Gold Exchange Traded Funds (ETFs)
  4. Sovereign Gold Bonds

Most of us purchase physical gold or jewellery. If you want to purchase gold for personal use, then purchase of jewellery makes sense. Otherwise, you must avoid purchasing jewellery as you would be unnecessarily paying making charges. Storage of physical gold can be a problem as there is risk of theft. However, it can be taken care of by taking a bank locker. Physical gold is quite liquid too.

Gold Mutual Funds and Gold ETFs have costs attached for management. Here too, the returns are linked to price of physical gold. However, these costs will eat into your returns. Though expense ratio is lower for Gold ETFs (compared to Gold Mutual Funds), ETFs have additional transaction costs (brokerage etc).

Gold MFs are quite liquid. You can redeem whenever you want. Liquidity can be issue at least in some of the Gold ETFs. If you want to invest in Gold ETFs, do check the daily trading volumes in the ETF.

What About Sovereign Gold Bonds?

Sovereign Gold Bonds were launched by the Government of India to present an alternative to investors in physical gold. To attract investors, these gold bonds offer interest income too. No other form of gold investment offers interest income. Though these gold bonds are not backed by physical gold (as in case of ETFs), these bonds are backed by sovereign guarantee. The return performance of the bonds will be linked to the price of physical gold.

Salient Features of Sovereign Gold Bond

  • Each Sovereign Gold Bond is equivalent to 1 gm of gold. If you purchase 10 gold bonds, you are essentially purchasing 10 grams of gold.
  • Gold Bonds are issued at simple average price of 999 purity gold in the previous week as published by Indian Bullion and Jewellery Association (IBJA).
  • You get an interest at the rate of 2.75% p.a. No other form of gold investment offers interest income. Interest is paid on the investment amount (and not on the basis of market value of your investment). Interest is paid every 6 months.
  • Gold Bonds mature in 8 years. On the date of maturity, your bonds will get redeemed at the prevailing gold price (previous week’s IBJA gold price). You will not get back physical gold.
  • You can redeem the gold bonds after 5th year on the interest payment dates.
  • These bonds will be listed on exchanges. Hence, you can technically exit the investment even before 5 years.
  • You are exposed to same price risk (fall in gold price) as in physical gold.
  • You can buy a maximum of 500 Sovereign Gold Bonds (equivalent to 500 gms of gold) per financial year. Minimum investment is 2 grams of gold.
  • Non-residents (NRIs) cannot invest in these bonds.

At What Price Were Previous Issues Made?

  1. First Tranche (November 5-November 30):  Rs 2,684
  2. Second Tranche (January 18-January 22): Rs 2,600
  3. Third Tranche (March 8 – March 14): Rs 2,916

You can see the issue price of Sovereign Gold Bonds has mirrored price of physical gold.

What Are the Risks of Investing in These Bonds?

By investing in these Sovereign Gold Bonds, you are essentially investing in gold. So, you are exposed to the same price risk. You will incur losses if the price of gold goes below your purchase price at the time of redemption. At the moment, there is an additional liquidity risk too. Though these gold bonds will be listed on exchanges, the liquidity may be quite low. It is quite possible that liquidity improves over a period of time. Sovereign Gold Bonds hold government guarantee. Hence, there is (almost) no default risk.

What About Capital Gains Tax?

If you hold physical gold in your portfolio, you can keep it as long as you want it.  There will no capital gains tax implications. Same applies to Gold mutual funds and gold ETFs.

However, with Sovereign gold bonds, you need to necessarily redeem gold bonds after 8 years. This would have given rise to capital gains tax implications. Fortunately, in the Union Budget 2016, taxation of Sovereign Gold Bonds has been brought at par with physical gold. There is no capital gains tax implication at the time of redemption of Sovereign Gold Bonds. Please note the exemption is only for redemption (at maturity) and not for sale in the secondary market. If you sell the bonds in the secondary market, there will be capital gains tax implications. If the capital gains are long term (>3 years), you will get indexation benefits too.

I Can Take Loan Against Physical Gold or Jewellery. What About Gold Bonds?

You can take loans against Sovereign Gold Bonds too. The Loan-to-value ratio for loans against gold bonds will be same as that for gold loans. However, if you foresee a scenario where you may have to take loan against gold bonds, it is better not to invest in these bonds.

Should You Invest in Sovereign Gold Bonds?

Depends on what you want to purchase gold for. You can’t wear Sovereign Gold Bonds around your neck. For that, you need to purchase jewellery. If you want to benefit from short term movements in gold price, you are better off investing in Gold Mutual Funds and liquid Gold ETFs. I do not expect liquidity in Sovereign Gold Bonds to be too high, at least in the near future.

However, if you are investing in Gold for diversifying your portfolio, then purchase of gold bonds may make sense. These gold bonds offer you a decent interest income too. 

Decision also depends on the comfort level of the investors. For many women, gold is much more than investment. It is an asset they can easily understand and buy and sell from a trusted jeweller. An interest rate of 2.75% p.a. is unlikely to make them give up physical gold and invest in Sovereign gold bonds.

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