Sovereign Gold Bond: Is it a good investment? Find out

April 16, 2020 11:37 AM

The Sovereign Gold Bond Scheme has many other exciting features that investors should carefully evaluate before making the investment decision.

Sovereign Gold Bonds, gold, Is it a good investment, Gold ETF, Coronavirus outbreakThe Government issues the bonds, and therefore, credit risk for the same is almost zero.

Gold has allured a large number of people across the world by its charm and beauty. Gold has a cultural significance and is considered precious. Traditionally people have invested in gold. Many households in India view gold as a good and safe investment, but the storage of gold in physical form is a matter of concern due to safety reasons. Further, storage of gold in bank lockers does attract some fees. To facilitated the Indian citizens to invest in physical gold, the government created an alternative saving option called ‘Sovereign Gold Bonds Scheme’ in 2015 under the Gold Monetization Scheme. The Reserve Bank issues bond on behalf of the Government of India. The gold bonds are released every month from October 2019 to March 2020.

The SGB scheme is less risky, convenient, and one has nothing to worry about risks, cost of storage. It is held in Demat form-eliminating risk of loss of scrip etc. and provides more benefit that is significant to investors compared to physical gold or Gold ETFs (Exchange Traded Funds). It is allowed to purchase gold in kilograms not required to hold the metal physically. Investors buy in cash, but the bonds will be redeemed in cash upon maturity. However, the bonds can be purchased during some specific times available. All Indian residents such as Individuals (Single or joint holding), HUFs, Trusts, Universities, Charitable institutions are eligible to invest in Sovereign Gold Bonds as per the Foreign Exchange Management Act, 1999.

A minor is also eligible for the scheme, but parents or legal guardians can apply the scheme on behalf of it. The bond is issued in denominations of 1 gram of gold with multiples of it. The minimum a single investor can invest is 1 gram of gold, and the upper limit is 4 Kg of gold (In case of joint holding, the limit applies to the first applicant), 4 kg for a Hindu-Undivided Family, and 20 kg for trusts, universities and other similar entities. Under the Government Securities Act, 2006, the gold bond will be issued as stocks, and a Holding Certificate of the same will be given to investors. It can also convert it to a Demat form.

The scheme has many other exciting features that investors should carefully evaluate before making the investment decision. The Government issues the bonds, and therefore, credit risk for the same is almost zero. Further, the bond provides interest at the rate of 2.50% p.a. which is payable semi-annually on the nominal value. Therefore, gold bond can give the returns in two forms, viz. capital appreciation as the gold price of the bond is linked with the gold price and interest income as against only capital appreciation accompanies by wear and tear due to physical holding of gold in the other option. Further, the gold bonds have a ready market, can be traded at the prevailing market prices, and thus provides liquidity. Since it is related to the market price of gold, the risk of capital loss may be there when the market rate of gold goes down, but it does not affect an investor’s units of gold. The gold bonds are traded in the secondary market, are redeemed at the end of eight years, and also have an exit option from the fifth year onwards. All three options provide adequate liquidity and surety of obtaining the value at which the gold is traded in the market. In case investors approach for premature redemption, request for early redemption can only be entertained if the investor at least one day before the coupon payment date approaches the concerned bank/post office.

Further, there is no transaction cost related to exit from the said scheme (provided the exit is not through the secondary market). There is also other cost savings for the investor opting for gold bonds, which include no storage cost, insurance for loss or theft. The scheme provides an exemption from capital gains tax if such gold bonds are held till maturity. This would act as a significant facilitator to the investors who desire to invest in gold for a long period, as it would lead to substantial tax savings on capital appreciation in gold prices. Further Sovereign Gold Bonds securities are eligible to use as collateral for loans from banks, financial Institutions, and Non-Banking Financial Companies (NBFC). However, it does not matter of right for the bank/financing agency to granting loans against SGBs. Some banks accept SGB as collateral/security against secured loans.

This scheme aims to minimize the generation of black money. Gold is one of the commodities that has been a victim of investment of black money in India. Though this scheme does not aim to bring the actual black money invested in gold within the purview of taxation, it aims to minimize future possible black money investment in this commodity. This scheme, thus, contributes to the robust and corruption-free nation-building activity of the Government. The price of the gold bond is tied to the market value of gold as a commodity. In the present context of falling interest rates, and Coronavirus outbreak, the gold prices are likely to appreciate in the future. In the global context, the US Fed rate cut is likely, and hence the sentiments for gold prices are high. This is because lower interest rates reduce the opportunity cost of investments.

The co-relation of gold prices with the stock prices is very low (at around 0.25) and, therefore, investments in gold act as an excellent diversifier to the existing portfolio. Investments in gold cannot give the returns as have been provided by the equity markets, but it can be used as an effective measure to reduce the volatility of the overall portfolio. Having evaluated various aspects of the gold bond, how it influences the lives of an ordinary person, it can be said that investment in the gold bond is a lucrative alternative when compared to holding gold in physical form. Therefore, it is advisable to invest in gold bonds to take advantage of such appreciation coupled with the interest income.

(By Dr. Naliniprava Tripathy, Professor (Finance), IIM Shillong. With inputs from Sushant Sant & Darshan Gosalia, PGP Students of IIM Shillong)

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