Sovereign Gold Bonds Revisited: Should you invest?

The Government is out with Second Tranche of Sovereign Gold Bonds. Applications for the bonds will be accepted from January 18, 2016 to January 22, 2016.

There is no difference in the bonds (from the first tranche issued in November, 2015) except the issuance price. In November, 2015, the Sovereign Gold Bonds were issued at Rs 2,684.

The issue price for the second tranche of Sovereign Gold Bonds is fixed at Rs 2,600 per gram of gold. Since the gold prices have declined since the issuance of first tranche, this was expected.

You can refer to the RBI press release for Sovereign Gold Bonds, 2016.

Must Read: Sovereign Gold Bonds: Should you invest?

How was the first tranche of Sovereign Gold Bonds received?

The first tranche of Sovereign Gold bonds saw good response.  There were approximately 62,000 applications received for ~916 Kg of gold. The total subscription was worth Rs 246 crores. Given the demand for gold in India, the amount may seem insignificant. However, if you compare the subscription amount to New Fund Offer (NFO) from mutual funds, I think it is a fairly good showing.

Sovereign Gold Bond is a new product. You can expect demand to grow as awareness about the product grows.

An additional reason for low demand (if you consider it low) for gold bonds in the first tranche was that the spot price of gold went down significantly while the issue was open for subscription.  The issue price was fixed beforehand (based on previous week’s average price of IBJA gold of 999 purity). Therefore, the investors could purchase gold at a much lower price in the spot market. The fall in spot price made Sovereign Gold Bonds unattractive to investors.

You can go through this Business Standard story  for more details.

You can expect this to happen again since the Sovereign Gold Bonds cause the greatest business risk to physical gold traders/miners. They will do everything in their right to make this gold bonds issue a failure. And that is an acceptable business strategy.

The issue for the first tranche was open for 15 days.  To partly take care of the aforesaid problem, the second tranche is open for issue for only 5 days.

Salient Features

1. Sale of the bonds is limited to resident Indians including individuals, HUFs, trusts, Universities and charitable trusts.
2. NRIs cannot invest in this tranche of Sovereign Gold Bonds.
3. Sovereign Gold Bonds are denominated in grams of gold.
4. Minimum investment limit is 2 grams of gold (2 bonds)
5. Maximum investment limit is 500 gm of gold per financial year.
6. In case of joint investment, the investment limit will be applied to first applicant only.
7. Interest will be paid at the rate of 2.75% per annum on a semi-annual basis (same as in the first tranche)
8. The Sovereign Gold Bonds will mature in 8 years though you will have an option to exit the position (by selling it back to the Government) after 5 years. Option to exit after the 5^th year can be exercised on interest payment dates (twice a year).
9. The bonds are proposed to be listed on exchanges. Hence, exit before 5 years is a possibility. A lot will depend on liquidity.
10. At the time of maturity, you will get back the price of gold prevailing at the time. Hence, if the gold prices decline, you may get back less than what you invested. You will not get physical gold.
11. The bonds have been issued by RBI on behalf of the Government of India. Hence, there is little default risk.
12. Since the redemption price is linked to price of gold, there is price risk. You would have borne the same risk if you had bought physical gold.
13. The Sovereign Gold Bonds can be used as collateral for loans just like physical gold.
14. These bonds can be purchased from banks and designated post offices. You can also invest online through portals such as ICICIDirect.
15. You can expect more gold bonds tranches in the future.

Is there any tax benefit on investment in Sovereign Gold Bonds?

There is no tax benefit on investment in Sovereign Gold Bonds.

Interest earned is taxable at the marginal income tax rate.

In case of capital gains at the time of sale or maturity, the tax treatment shall be same as for physical gold.

Short term gains (holding period <= 3 years) shall be taxed at the marginal income tax rate (as per income tax slab of the investor). Long Term Capital Gains shall be taxed at 20% less indexation.

Must Read: PFP Primer: How are your investments taxed?

Where are the gold prices headed?

I don’t know. I am no expert in commodity pricing and have no experience in trading in commodities. Hence, I will refrain from making any prediction. However, I found an excellent video from Deepak Shenoy, Founder, Capital Mind.

You can view the video here. He has an interesting take on how Gold Bonds are going to affect gold prices.  I quite subscribe to his view.

Your opinion might differ.

Whether I should invest in Sovereign Gold Bonds?

I have discussed this in detail in my previous post on gold bonds. The Sovereign Gold Bonds offer 2.75% per annum interest rate. No other form of gold investment gives you interest income.

However, you can face liquidity issues. Hence, gold bonds won’t fit if you plan to purchase gold for your daughter’s marriage in 3-5 years.  You are better off buying physical gold in this case.

If you plan to purchase gold for the marriage which is 20 years away, invest in equity mutual funds. As you move closer to this goal, you can gradually liquidate equity investments and purchase physical gold.

Moreover, gold bonds will mature in 8 years (you have no discretion).  You will have to pay capital gains tax. If you had purchased physical gold, you could have avoided capital gains tax altogether (Well, there has to be redemption or sale for capital gains to arise).

My opinion is that you should look at these bonds only if you want to diversify your portfolio and get the asset allocation right. If your investment portfolio does not have gold, you can consider these bonds. In such cases, Sovereign Gold Bonds are better than any other form of gold investment.

Are you planning in this second tranche of Sovereign Gold Bonds?

Image Credit: Jeremy Schultz, 2007. The original image and information about usage rights can be downloaded from Flickr.