Gold bonds can reduce the demand for physical gold, but the metal has lost its lustre as it has given negative returns since 2013.
The government has launched subscription for the second tranche of gold bond till January 22. The rate has been fixed at Rs 2,600 per per gram of gold based on the basis of simple average of closing price for gold of 999 purity from January 11-15 published by the India Bullion and Jewellers Association.
A sovereign gold bond is an alternative to addressing the investment demand for the yellow metal. It was launched last year in November in an effort to reduce demand for physical gold by providing an alternative investment instrument linked to gold.
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. Investors can get a certificate or hold it in a demat format and it can be used as collateral for loans.
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 issued by Reserve Bank of India on behalf of the government, are denominated in grams and sold through banks and designated post offices. The minimum permissible investment will be two grams of gold with the maximum 500 grams per person in a financial year. 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.
In the first tranche, the government’s sovereign gold bond scheme had attracted deposits worth Rs 246 crore. 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 31 straight month of outflows till December last year.
Unlike gold ETFs, liquidity in gold bonds is 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. The value of the gold bond is subject to the volatility of the gold as gold bond can give negative return if gold prices go down.
Gold ended with negative returns in 2015 for the third year in a row. In rupee terms, spot gold dropped 6% in 2015 and around minus 8.5% CAGR for the period 2013-15. Analysts expect even 2016 to be no different with gold maintaining its weak trend as the dollar is at its strongest in 10 years.
Moreover, the US Federal Reserve has moved towards tightening the monetary policy after almost nine years and there is a high chance that they will continue to hike rates this year. Analysts say this would lead to an increase in demand for dollar and put pressure on prices of commodities such as gold, silver, oil and copper. While gold is known as a hedge against inflation, most global economies are in a deflationary mode and the possibility of inflation moving up in the next few months looks very remote. Analysts say this will keep gold prices subdued for some time now.
Indian household savings have moved away from gold to financial instruments. For only the third time in the last 15 years, bank fixed deposits were the best performing assets last year, outperforming equities, gold and real estate. So, the demand for the metal is expected to reduce as households move away from physical investment to financial instruments like fixed deposits, bonds, equity because of negative returns by gold in the last three years.
* Gold bonds score over ETFs as the former will earn an interest
* However, unlike gold ETFs, liquidity in gold bonds could be an issue
* Gold ETFs are a convenient way to invest in the yellow 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
* You will save the expense of locker as a gold bond can be kept in your house or demat account
* There is no chance of cheating or impurities in the gold bond