The smart way to invest in gold

March 8, 2016 . Bhavana Acharya

You would think an Exchange Traded Fund or a gold fund is the answer to the best way to invest in gold. And you would be right, until a few months ago. But when the government came out with its Sovereign Gold Bond scheme in November last year, the advantages gold ETFs had paled considerably. Now, with taxation changes proposed in the Budget last month, Sovereign Gold Bonds now thoroughly eclipse any other mode of gold investing.

gold2The third tranche of Sovereign Gold Bond issue is open from today to 14th March. The issue price for this tranche is fixed at Rs 2916 per gram of gold.

Interest income
Sovereign Gold Bonds are issued by the Reserve Bank of India and have a solid government backing. The maturity of each bond is eight years from the date of issue with an exit option from the fifth year. They can be held on behalf of a minor or even jointly. You will be issued a Holding Certificate for the gold and this can be converted into demat form. The bonds are denominated in grams.

The issue price is arrived at by averaging the preceding week’s gold price. In this tranche, say you want three grams of gold. You will have to invest Rs 8,748. At the time of redemption, the prevailing market value of these three grams will be paid out. The redemption price is arrived at the exact way the issue price is fixed. Therefore, you do get the potential of capital appreciation. That’s true for gold ETFs too.

But here’s the first way the Sovereign Gold Bond scores. The bonds will pay an interest of 2.75 per cent per annum, payable every half year, on the amount of the initial investment. The last interest will be paid out along with the redemption proceeds. An interest of 2.75 per cent looks measly. But all other forms of gold investments – coins, jewellery, ETF, gold funds – have no interest payment at all. An investment of Rs 10,000 will earn an approximate amount of Rs 2,200 over the course of 8 years in interest alone. And remember, this income is in addition to the potential capital appreciation.

Taxation benefits
In physical gold, gold ETFs, and gold funds, long term capital gains are taxed at 20% with indexation benefit. In a Sovereign Gold Bond, long term capital gains are not taxed if the bonds are held to maturity. This is the second big advantage of these bonds. The change in taxation of these bonds was announced in the Budget last month.

Of course, if you transfer the bonds (this is allowed from the fifth year from date of issue) before maturity, your gains are not tax-exempt. The question of short term capital gains does not arise since the minimum lock-in for these bonds is five years unless you trade on them. Interest is treated as income and taxed accordingly in your hands. Even so, overall returns if gold prices appreciate will be higher than other gold investments.

Better prices
The primary benefits of sovereign gold bonds are the two listed above. The other benefit is better prices. Gold jewellery carries the drawback of making charges and wastage, whether at the time of buying or selling. Storing the gold safely is an added cost due to locker rents. You would also need to put in a bigger sum to buy gold jewellery. Gold schemes run by jewellers are not risk-free either. Financial gold (ETFs, gold funds, sovereign gold bonds) don’t suffer from any of these drawbacks.

But ETFs and consequently gold funds have one risk. The traded price of ETFs may not accurately reflect the underlying gold price or NAV because of demand-supply market volumes. Your gains, therefore, will be different from the gold price trends. Sovereign gold bonds don’t have this possible risk.

The bonds will be listed on the exchanges by the RBI after a specific date and can be traded. The bonds can be used as collateral for loans as well, subject to the same loan-to-value conditions as physical gold loans. You need to fill up an application form, comply with basic KYC, and pay for the bonds through cheque, DD, or electronic modes.

As far as gold investment goes, the combination of interest income, capital appreciation, and favourable taxation make sovereign gold bond funds stand above other gold instruments. You would, however, have to necessarily have a long-term horizon when you invest in sovereign gold bonds due to the long tenure. But since gold investments are meant as a hedge for inflation and for portfolio diversification, such a long term horizon will actually be a good fit.