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Should you invest in the forthcoming Sovereign Gold Bond issues?

With gold prices looking up this year, should you consider investing in it?

Reserve Bank of India is planning to issue Sovereign Gold Bonds (SGB) every month till September of this year (see table). SGBs are government bonds denominated in grams of gold and linked to its market price. 

With gold prices looking up this year, should you consider investing in it?

Features

First of all, let’s understand its salient features.  These bonds have tenure of eight years and come with a sovereign guarantee (negligible risk of default that is). 

The nominal value of these bonds is fixed on the basis of simple average of the three-day closing price (preceding the subscription period) of gold of 999 purity.  So, at current prices, the issue price is likely to be fixed at about Rs 4,700 per gram. At the time of redemption, one gets an amount equal to the (then) prevailing gold prices and grams of gold owned. 

In addition, these bonds bear a fixed interest of 2.5 per cent on the initial investment – which is payable semi-annually. 

Better than physical

SGB is a superior alternative to investing in physical gold – be it in the form of coin or jewellery. While buying jewellery, one incurs making charges which could be anywhere from five to 20 per cent of the jewellery cost. When you sell it back to the jeweller, you lose out on these charges. Moreover, there is a worry about purity and safe storage of physical gold. 

In contrast, SGBs, as well as gold funds, let you own gold in paper form, without worries about its purity or making charges. 

While SGB does not charge anything, gold funds have an average annual expense ratio of 0.5 per cent. 

Liquidity challenges 

The bond has a tenure of eight years with the option to surrender it early - in fifth, sixth and the seventh year. However, on exiting early, investors lose out on tax advantages. 

While the SGBs are also listed on the exchanges within a fortnight of its issuance, it is traded infrequently. Earlier bonds are currently quoting at a discount of up to six percent to prevailing gold prices. 

In times of Covid, when businesses and jobs look vulnerable, it is prudent to keep ample liquidity. Investing in bonds with huge lock-ins might not be a wise option now.

Gold funds, in contrast, tend to be highly liquid and can be redeemed quickly.

Tax treatment

Appreciation in bond value (based on gold price movements during the tenure) constitutes the capital gain. There is no tax on capital gains made from investing in SGBs, if held till maturity. However, there is 20 per cent tax (along with indexation benefits) if redeemed prematurely after three years or more. Similarly, capital gains from investing in gold funds for three years or more entails a 20 per cent tax along with indexation benefits.

Moreover, the interest earned on the SGB investment every year is subject to taxes at the marginal rate. 

Gold as an asset class

The equity market has corrected sharply this year with the spread of Covid-19 virus in the country. Falling interest rates, in turn, has reduced the returns from fixed income instruments. On the other hand, gold prices are up by 22 per cent this year.

Historically, gold prices have shot up during economic crisis or escalation of political tensions, thanks to its safe-haven status. However, gold has earned the bulk of its returns from rupee depreciation and not from the appreciation of its intrinsic value. 

Unlike equities, their price movements are more erratic and sometimes gold investors have to cool their heels for a longer time. For instance, investors who had bought gold at the peak in 1980 would have had to wait for 27 more years just to see its prices get back to the same level.

Investors are better off treating gold as a small part of their portfolio. They could consider investing in a mix of SGB and gold funds if need be.

Takeaway

In tough times like these, liquidity is vital. Investors are better off avoiding instruments that have lock-ins. Gold at best can be a small part of your portfolio and no more.

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