Investing in sovereign gold bond scheme at high prices could be risky

Entering this long-term instrument could cause distress if the rally ends in some years

The Sovereign Gold Bond Scheme (SGB) 2020-21-Series V is open for subscription from August 3-7. The price of this tranche has been fixed at Rs 5,334 per 1 gram of gold. Investors need to carefully decide whether they should lock in their money in SGBs for the long term at the current high prices or consider more liquid alternatives, like gold exchange-traded funds (ETFs).

The primary factor responsible for the ongoing bull run in the yellow metal is the global economic downturn. Says Feroze Azeez, deputy chief executive officer, Anand Rathi Private Wealth: “Gold prices have seen unprecedented highs due to the economic uncertainty triggered by the Covid-19 pandemic. If not for it, gold would not have seen these levels.” Gold had touched Rs 53,000 per 10 grams in the past month.

Experts caution against the current high prices. Says Pankaj Mathpal, founder and managing director, Optima Money Managers: “Between the April tranche and the latest one, the price of SGB has increased by approximately 15 per cent, making it very expensive right now. It is unlikely that the current momentum in gold prices will continue.”

If we are closer to the end of the rally in gold, investors could be disappointed if they lock themselves in an instrument like SGB, which has an eight-year tenure. Experts believe the current rally may not last beyond two years. They believe gold prices could correct by 20-25 per cent in two years.

Those accumulating gold for a consumption-oriented goal may still buy. If you are buying it in small amounts for your daughter’s marriage, which is a decade or so away, you may still buy. But if you are buying for inves­tment, your decision-making criteria should be different. Ideally, investors should maintain an allocation of around 10 per cent to the yellow metal. Says Mathpal: “Only those who don’t have any exposure to gold should consider buying at such high prices.”

While the annual 2.5 per cent interest makes SGBs attractive, they have a few disadvantages. One is liquidity. SGBs mature after eight years. Investors can exit prematurely by selling them back to the issuer after five years. These bonds are also listed on the stock exchanges. However, if you trying to exit via this route, you will have to sell at a discount.

Those wanting to invest now may avoid the primary issue and buy these bonds at a discount from the secon­da­ry market and sell when prices climb higher or redeem them at maturity. Says Azeez: “Listed SGBs are quoting Rs 51,800 today, i.e., 2 per cent less than the current price.”  

Globally, gold-backed ETFs have seen net inflows of about $39.5 billion this calen­dar year, according to the World Gold Council. Indian investors, too, may consider them. While SGBs offer an interest rate of 2.5 per cent annually, gold ETFs charge an annual expense ratio. Nonetheless, investors who have a shorter investment horizon and want liquidity may consider gold ETFs, which are easy to exit by selling on the stock exchanges.

Interest earned on SGBs is taxed by being added to income. It is then taxed at the slab rate. Says Gopal Bohra, part­ner, NA Shah Associates LLP: “No cap­ital gains tax is payable by an indi­vi­d­u­al on the redemption of SGBs on ma­t­u­r­ity. However, this tax is payable if one transfers SGBs before maturity, just as you would pay on the transfer of phy­sical gold, ETFs or gold mutual funds.”