Unlike gold exchange-traded funds (ETFs), the bonds will not be backed by gold but a sovereign guarantee.
The government has launched three gold-related schemes, aimed at reducing the country’s dependence on imports and channelising household gold into productive use. A sovereign gold bond is an alternative to addressing the investment demand for the yellow metal.
Unlike gold exchange-traded funds (ETFs), the bonds will not be backed by gold but a sovereign guarantee. The investors will get interest at 2.75% a year, payable semi-annually, on the initial value of investment for the bonds issued in 2015-16. The bonds will be issued by Reserve Bank of India on behalf of the government, denominated in grams and sold through banks and designated post offices. The minimum permissible investment will be two grams of gold with the maximum not more than 500 grams per person in a fiscal year.
The bonds can be bought by resident Indian entities, including individuals, HUFs, trusts, universities and charitable institutions. The bond will have a tenure of eight years with an exit option from the fifth year. On maturity, the bonds would be redeemable in cash and the principal amount of investment (which is denominated in grams of gold) will be redeemed at the prevailing gold price. The price will be linked to the previous week’s simple average of closing price of gold of 999 purity published by the India Bullion and Jewellers Association. Investors can get a certificate or hold it in a demat format and it can be used as collateral for loans.
The certificate indicates the amount, date and the quantity of gold bought by the investor. The interest earned on gold bonds would be taxable and capital gains tax shall be levied as in case of physical gold. As the bonds will be listed on the exchanges, investors will get an option to exit if volumes traded on the exchange are good. Applications to purchase the bonds can be submitted from November 5–20, 2015, to the banks and designated post offices. The bonds will be issued on November 26.
Gold bonds or ETFs?
While most Indians prefer to invest in the precious metal in the physical form, gold ETFs of mutual funds are a convenient way. They are open-ended funds that trade on a stock exchange just like the shares of a company and track closely the price of physical gold. Each unit of the ETF is equivalent to one gram of gold and it provides an opportunity to investors to accumulate gold over a period of time. With the fall in gold prices, ETFs have reported 29 straight month of outflows till October.
Naveen Mathur, associate director, Commodities & Currencies, Angel Commodities Broking, says, while gold ETFs can be sold at transparent prices, they come at a cost. “A fee is charged by the fund house, so the return is slightly less than the actual increase in gold price. Moreover, there are additional costs involved at the time of buying and selling in the form of brokerage or commission,” he says.
Gold bonds are a better way to invest in the metal as the investment will earn an interest. Vidya Bala, head of mutual funds research at FundsIndia, says sovereign gold bonds are a superior option for those looking to invest in gold.
“On top of getting the market price of gold at the time of maturity, investors will be incentivised with a 2.75% annual interest. This unique product, therefore, gives a financial product-like return, tagged with the appreciation of gold,” she says.
Unlike gold ETFs, liquidity in gold bonds could be an issue. As gold ETFs are actively traded on the exchanges, one can easily liquidate their position any time during the market hours. Also, pricing of the bonds may be a issue for some investors.
“For the current bond, the price is fixed at Rs 2,684 per gram for 999 purity. However, the current rate of gold is lower than the issue price. The pricing for the bonds should be dynamic where investors get the price on the day of investment or the price on the allotment day — this will help resolve this issue,” says Chirag Mehta, senior fund manager, Alternative Investments, Quantum AMC.
Gold prices have dropped nearly 5% in the last six months on the growing probability of the US Federal Reserve hiking the interest rates in December. Analysts say gold prices are likely to remain range-bound till the Fed raises the interest rate and, when it happens, there could be initial panic selling of the metal in the global market. As buying gold is considered auspicious during the festive season, one can consider gold bonds to diversify the portfolio and reduce the overall risk.
MATTER OF CHOICE
– Gold ETFs of mutual funds are a convenient way to invest in the metal. They are open-ended funds that trade on a stock exchange just like the shares of a company and track closely the price of physical gold
– Each unit of the ETF is equivalent to one gram of gold and it provides an opportunity to investors to accumulate gold over a period of time
– Gold bonds score over ETFs as the former will earn an interest
– However, unlike gold ETFs, liquidity in gold bonds could be an issue
– As buying gold is considered auspicious during the festive season, one can consider gold bonds to diversify the portfolio and reduce the overall risk