Soaring gold prices & the glint of sovereign bonds for the metal

The first tranche of the sovereign gold bond (SGB) matured recently and brought much cheer to investors with a CAGR of 10.88% per annum (p.a.), absolutely tax free. Investors have been checking about upcoming trachea and those who have not invested till now are considering the SGB. In this pursuit, the recurring investor are: 

1. Will other tranches give similar returns, and 

2. How to allocate between various gold investment choices.  

Gold has always been a market-linked return product, irrespective of the form in which it is bought. Gold has returned between 1% and 22% p.a. in 8 year periods with an average return of 9% p.a., considering the investment period between January 1980 to January 2015. However, between January 2000 and January 2015, gold returns have been below 5% p.a. for only three 8 year periods. Gold returns depend on many factors such as inflation, interest rates and geopolitical situation and can waver greatly. Investors looking to subscribe mustn’t invest assuming 10-12% p.a. returns, based on the performance of the first tranche.  

Indians have traditionally preferred physical gold due to the sense of security it provides, given its tangibility. But they do not account for the massive overhead charges – almost 30% in case of jewellery and 5% in case of coins. These overhead charges are in the form of making charges, wastage etc. Furthermore, selling gold for cash is not easy especially with older jewellery items which may not be hallmarked. Also, sale of gold attracts capital gains. 

A better alternative which is zero cost and tax free at maturity is SGB. The 8-year lock-in should not be a deterrent as people tend to hold gold for long, preferring to take loans for any emergency. SGB also has no headache of storage or risk of theft or purity issues and can be subscribed through the bank account. 

Gold ETFs have lost their sheen due to change in the tax structure from this financial year. Gold ETF returns are now fully taxable irrespective of the period of holding. However, they win over physical gold due to much lower costs (0.5-1% p.a.) and ease of transaction.  

The investment decision between physical gold, gold ETF and SGB is to be based on usage and period of holding. If the reason for purchase is investment, then there is no point in paying 30% overhead charges and investing in jewellery. SGB suits this purpose better.

Even when investing in gold for future use, say a daughter’s marriage, keep in mind that the younger generation may not prefer the current designs and 5-20% is lost in exchanging gold ornaments. Buy jewellery for current use and deploy the rest of the desired gold allocation into SGB. If the holding period is less than 8 years, go for gold ETF