Yellow metal adds sheen: Should you invest in sovereign gold bonds or ETFs?

Those with long horizon should use sovereign gold bonds; short- to medium-term horizon may consider gold ETFs

The spot price of gold touched the Rs 40,000 per 10-gram mark in intra-day trade on the MCX last week. Gold exchange-traded funds (ETFs) have given a category average return of 24.6 per cent over the past year. This sharp upsurge in the price of gold has once again sparked investor interest in the yellow metal.

Several factors are responsible for the recent rise. “We are moving towards an environment of slow growth globally. Central banks are cutting interest rates. Later, they may undertake unconventional measures like printing currency. Both nominal and real interest rates are moving lower and have even turned negative in many parts of the world. Such an environment is positive for gold,” says Chirag Mehta, senior fund manager-alternative investments, Quantum Mutual Fund.

The ongoing trade war between the US and China, and depreciating emerging market currencies are other factors responsible for gold’s strong showing.  

Investors, who do not have any allocation to gold, should not worry about having missed out on the rally. “Gold has not performed for the past five-six years and hence, has a lot of catching up to do. It is likely to do well for the next three-four years,” says Kishore Narne, associate director and head of commodities and currency, Motilal Oswal Financial Services.

Investors should have a 10-15 per cent allocation to gold. Those currently building an allocation to the yellow metal should invest systematically in it over time and buy on dips. Those looking to invest in gold (rather than use it as a consumption item—in the form of jewellery) should stick to gold-linked financial instruments such as sovereign gold bonds (SGBs) and gold ETFs.    

SGBs are suited to investors with a long investment horizon of more than five years. They offer an interest rate of 2.5 per cent annually on the initial investment amount (in addition to capital gains). “No taxes are levied on the proceeds from SGBs if they are redeemed at maturity,” says Archit Gupta, founder and chief executive officer, ClearTax.  

On the flip side, SGBs are not liquid. So, an investor wanting to sell them before five years, to, say, rebalance his portfolio, will find it difficult to do so. Exit is permitted after five years (by selling back to the institution they were purchased from). Those who want to sell before five years may do so on the stock exchanges (provided the SGBs are in demat form).

“But liquidity is low and these bonds usually trade on the exchanges at a discount to the parity price,” says Mehta. Parity price is the international price converted into Indian rupee using the exchange rate, plus duties and taxes. Also, SGBs are not available on tap. The government offers them in tranches for limited periods.

Gold ETFs are a more liquid form of investment. “Since they are backed by physical gold, they offer liquidity at the right price,” says Mehta. However, investors have to pay an annual expense ratio of 0.35-0.97 per cent. “Over a 10-12-year period, the expense ratio eats away a considerable portion of the return,” says Narne.

Investors with a horizon of five years or more may opt for SGBs, while those with a short- to medium-term horizon will be better off going for gold ETFs.

Those investing in gold now because they will need physical gold at a later date may consider digital/e-gold. At the time of redemption, if you want cash, you would end up paying a commission of 6-7 per cent. But those taking delivery of physical gold will only have to pay the making charge for the coin.