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Why bond with gold?

Rajalakshmi Nirmal | Updated on January 16, 2018 Published on October 08, 2016

Sovereign Gold Bonds have mopped up a huge amount in the last two tranches. Investors tell us what they find attractive about the scheme

While reports from the World Gold Council indicate a drop in investment demand (down 17 tonnes) for gold in India in the first six months of the year, the Centre’s new gold scheme — Sovereign Gold Bonds — has mopped up a huge amount. In the last two tranches, the Centre received about 2 lakh applications , up from about 62,000 applications in the first tranche in November 2015. In the five issues so far, sovereign gold bonds have raised money worth 10.22 tonnes or 10,220 kg of gold.

In an online survey by Business Line which received over 200 responses, 65 per cent said they knew about the scheme, with one in every five in the group having bet money on it. According to those surveyed, the prime attraction in these bonds is that they are in a de-materialised form and there is no capital gains tax on them if held till maturity.

Interest adds to the appeal

Sovereign gold bonds are a proxy to investing in physical gold. These bonds are issued by the Government of India and offer returns linked to gold price. The carrot is that, investors also get a coupon of 2.75 per cent per annum (payable semi-annually). The minimum investment starts from 1 gram (1 unit) with a maximum of 500 gram (500 units) for each individual in a year.

Small-time retail buyers of gold, who purchase jewellery with the intention of planning for their daughter’s wedding which may be a few years away, show interest in these bonds.

Indra Priya, a home-maker in Chennai with a 17-year-old daughter, says, “I have invested in these bonds for my daughter. When I buy gold as jewellery I will have to cough up making charges, but in this case, I buy it at the market price. Also, if I buy jewels now and later she doesn’t like them, I will have to sell them and forego a few grams that will be deducted as wastage. So, I thought it is better to invest in gold in electronic form now and when it matures after eight years, take the money and buy the jewellery she likes then…”

The interest portion on these bonds adds to the attraction. Karthick (name changed on request), a 45-year old media professional and father of two girls who invested in the first two tranches of the sovereign gold bond, says, “I found the product very attractive. As I have two daughters, I will have to anyway buy gold for them, and these bonds with their 2.75 per cent interest seem a good option”

R Jeyaraman, a retired banker from Thanjavur, has invested a large amount in the last two tranches of the gold bond. But his story is different. “All my money was in fixed deposits. But once I got to know through my friend who is also a bank manager about this gold bond, I was keen to invest in it. FDs give me only under 9 per cent, but in these bonds I will get returns linked to gold price and an additional interest of 2.75 per cent….”

Gold doesn’t always shine

Investors have to note that there is no capital guarantee on these bonds. On maturity, the bonds will be redeemed at the then prevailing market price of gold.

“I have seen gold trade at ₹500/gram in the 1970s when I was a bank manager in Thanjavur, but today it is close to ₹3,000/gram. So, gold price will only move up I think,” says Jeyaraman, voicing the thoughts of many of his age who have seen gold prices skyrocket in the last 50 years.

But ignoring the fact that gold has also had its bad years may be a costly mistake. Though the yellow metal has zoomed from $48/ounce in the 1970s to $1,300/ounce now, it works out to a CAGR of less than 9 per cent annually. Between 2011 and 2015, the metal lost about 40 per cent.

The investment tenure in these gold bonds is eight years and it allows redemption from the fifth year. If you want to exit these before five years, you can do so in the secondary market.

Diversification tool

Sovereign gold bonds are listed both on the Bombay Stock Exchange and the National Stock Exchange. These bonds trade on dirty price, which is price inclusive of accrued interest. So, at any point, an investor who sells these bonds in the secondary market will exit with the interest accrued on the bond (since the date of issue or date of last payment of interest) while the person who buys the bond will get the interest credited to his account by the government (whenever it falls due). The interest of 2.75 per cent is on the amount of initial investment. Interest payments on these bonds are taxable as per the individual’s slab rate.

Investors who look at gold as a diversification tool to reduce the risks of an equity portfolio also invest in gold bonds. Neeraj Aggarwal, a Chennai-based businessman, who has put his money in these bonds, says, “About 10 per cent of my portfolio is in gold now. Since it is in electronic form, and is issued by the Government of India, there are no risks and I like the product as it diversifies risks in my equity portfolio…”

Buy smart

Investors who have missed the bond in the issue period can buy it in the market (the next issue is likely to be close to Diwali).

These bonds are listed on the bourses. Indra Priya bought the gold bonds in the secondary market. “I came to know about these bonds only after the issue was closed. But I bought it from the secondary market through my stock broker…”

However, note that the volumes in the secondary market are low.

The I, II and III tranches of these bonds see only 10-15 units being traded on a daily basis on the NSE. The IV tranche of this bond (issue price ₹3,119/gram) is witnessing trades of about 500-1,000 units.

Much of the buying in these bonds has been happening only at the time of issue, say broking houses. In the secondary market, the bid-ask spread is wide and the volumes are low.

So, if you are looking to buy bulk quantities of these bonds, you may not be able to do it at one go. Similarly, if you want to sell 100-200 bonds at one go, that will also be difficult.

Do also note that investors who prematurely exit these bonds are liable to pay capital gains tax.

Capital gains tax exemption on sovereign gold bonds is given only to investors who hold the bond till maturity (eight years). For others it will be taxed at 20 per cent (with indexation benefit) if sold after three years. On exit before three years, capital gains will be taxed at the slab rate.

Allotment delay

Investors who opted for sovereign gold bonds say the investment process is quite simple. Most of them did it through their stock brokers or banks. But one hiccup is the delay in the allotment post the issue.

Many complain that their broker or banker kept them in dark on when they would get the allotment. Some also point to the short issue periods in all the tranches which makes it difficult for them to arrange funds.

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