After having a subdued year in 2021 gold prices have moved up sharply during 2022 – triggered mainly by the geopolitical events in Ukraine.
The price of gold which was $1,827 per ounce (an ounce is equal to 31.10 grams) at the beginning of this year shot up to $2,052 on March 8 before settling at $1,927 currently.
The price of gold normally goes up during turmoils like the Ukraine war making gold the most preferred asset class. Stock markets even after correcting 7% from the peak look expensive as prices have run ahead of fundamentals.
Inflation also has been a worry with CPI inflation rising to a nine-month high of 6.7 % in February which is more than the 6% upper band that the Monetary Policy Committee (MPC) has been mandated to maintain.
Households normally use gold as a hedge against inflation. Bonds & bank FDs haven’t been great investment avenues because of low-interest rates. Is this the right time for you to invest in Gold?
And where should you invest? In physical gold? In Sovereign Gold Bonds scheme? Or in Gold exchange-traded funds?
Let’s try to understand the nuts & bolts of investing in gold, possession of which adds to the social status of the households in India.
Gold as an asset class
Experts suggest having gold in the portfolio since it has a negative correlation with equity. However, they suggest that exposure to it should not be more than 10% to 15 % of the portfolio consisting of equity shares, fixed income or debt, real estate & cash.
Physical gold in the form of jewellery, coins & bars involve cost related to storage and are exposed to the risk of burglary, theft, or fire. When you want to sell them too there could be conversion, making charges et cetera.
This is where Sovereign Gold Bonds or Gold ETFs which are like mutual funds that track the price of gold make sense.
Features of Sovereign Gold Bond Scheme & Gold ETFs
Sovereign Gold Bonds or SGBs are bonds issued by the Reserve Bank on behalf of the government denominated in grams of gold. RBI has been issuing gold bonds every year in tranches since November 2015. The subscription period for the last tranche closed on March 4, 2022 and the offer price was Rs 5,059 per gram.
The price of the Bond is fixed in Indian Rupees based on the simple average of the closing price of gold of 999 purity published by the India Bullion and Jewellers Association Limited (IBJA) for the previous three business days of the week. They have a tenure of 8 years. Individuals are permitted to invest up to 4 kgs in a financial year.
Gold Exchange Traded Funds, or Gold ETFs are open-ended mutual fund schemes, and their value goes up & down in line with the price of physical gold.
Physical gold, on the other hand, is idle & does not generate any income. One unit is equal to one gram of gold and an investor can buy any number of units and hold it in the Demat account in an electronic form.
Liquidity
Gold exchange-traded-funds (ETF) score over Sovereign Gold Bonds (SGB) in terms of liquidity since an investor can redeem units at any time at the prevailing price. Though SGBs are traded on stock exchanges their traded price is lower price than the reference price and hence suffers from liquidity. For others holding the bonds in the physical form, they can be redeemed only after 5 years.
Returns
Though gold ETFs & SGBs reflect the market price of gold and should give identical returns, the returns in ETFs will be lower because of the brokerage & fund management charges that the investor pays which are absent in SGBs.
Investors in SGB also get a guaranteed 2.5% interest on their investment every year till maturity which is over & above the returns that they may get when gold prices appreciate.
Taxation
Gold ETFs are subject to short term capital gains (STCG) if held for less than 36 months and taxed as per the tax slabs of the investor, they are exposed to long term capital gains (LTCG) if held for more than 36 months & are subject to 20% tax with indexation. In the case of SGB, the investor is exempt from LTCG tax if he keeps the Bonds till maturity and gives the investor higher returns. The trade-off for liquidity is the exemption from LTCG.
(The writer is a CFA & a former banker & currently teaches at Manipal Academy of BFSI, Bengaluru)
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