Get ready to bond with gold

The government recently flagged off two gold schemes announced in this year’s Budget — the gold monetisation scheme and the sovereign gold bond scheme. Of these, while the monetisation scheme is targeted at those who have old gold to trade in, the gold bond scheme is an attractive option for investors seeking to buy gold.

In fact, the draft guidelines of the scheme, which are now available, suggest that gold bonds may even be a better investment option than gold exchange-traded funds (ETFs).

The proposed gold bonds will be issued by the Reserve Bank of India and sold in denominations of 5/10/50/100 gm for tenures of five and seven years.

Like any other bond, gold bonds too have to be bought for cash. They will be available in both demat  and paper forms, but will be open only to resident Indians.

Appreciate the features

Going by their features, gold bonds score over other forms of paper gold on several parameters. One, these are backed by a sovereign guarantee. The bonds will be issued by the RBI on behalf of the government of India. Two, as this is a bond, investors will be paid interest.

While all other forms of gold — physical gold, gold ETFs or gold funds — offer only capital appreciation by way of returns linked to gold price, investors buying gold bonds stand to earn interest income.

The interest rate will apply on the value of gold at the time of investment.

The actual rates, which are yet to be announced, will take into account domestic and international market conditions and could be fixed or floating, as decided by the government.

Shekhar Bhandari, Senior Executive Vice President & Business Head – Global Transaction Banking & Precious Metals, Kotak Mahindra Bank, says, “The current indication is that these bonds may carry an interest of 2-2.5 per cent per annum.”

Also, while in gold ETFs and gold funds, there are transaction charges plus a fund management fee, which will have to be borne by the investor and could eat into returns, in gold bonds there will be no such expense.

Distribution charges, including agent’s commission, will be borne by the government. The agency (bank/post office) that redeems the bond may charge a small fee for the service.

So, if you are planning to buy gold for your daughter’s wedding, which you expect in the next five years, rather than buying gold coins or jewellery, where you have to cough up locker charges to safe-keep the gold, or gold ETFs where you have to pay transaction fees and broking charges, these bonds can be a more cost-effective way of owning gold.

The other advantage is that these bonds can also be used as collateral for loans. The LTV (loan-to-value) will be equal to the normal gold loan. Capital gains tax on gold bonds will be the same as that for physical gold or ETFs, where  long-term capital gains tax will apply on holdings for three years or more with tax levied at 20 per cent after indexation.

But what if gold prices fall from the time of investment? Will the investor suffer loss on redeeming the bond?

No. In such a situation, the investor will be given an option to extend the bond for three years or more.

The sovereign gold bonds will be redeemed for cash at the end of the investment tenure. Redemption will take place at the prevailing gold price, giving the investor the value of the bond plus capital appreciation from increase in gold price.

But, if gold prices decline during this period, the investor will be allowed to stay put for another three years or so.

Some pitfalls

One pitfall with this scheme is that it restricts investment to 500 gm a year. There is no such investment cap for gold ETFs or gold funds.

Gold ETFs or funds may also allow you to time your investment better to the lows or highs in gold prices by offering better liquidity. Gold bonds offer less flexibility on this count.

Though the government has said that these bonds will be allowed to be traded on commodity exchanges, in the initial few years, there might be limited liquidity in the secondary market for these bonds.

But, if you are a long-term gold bull and can hold for seven years, you need not worry about secondary market volumes.