Gold bonds will score over ETFs

Invest in these for the long term; a Fed rate hike and an import duty cut by the government could trigger a correction in the next few months

After giving negative returns in the previous three calendar years (2013-2015), gold has rallied around 20 per cent in the Indian market year-to-date. Having run-up so much, there is a question mark on whether the yellow metal can repeat its stellar performance in the near term. The possibility of one Fed rate hike this year and a couple more in 2017 also casts doubt on the yellow metal’s prospects in the short term. Experts are of the view that only investors with a long-term investment horizon should invest in the latest tranche of sovereign gold bonds issued by the government.

 

The sixth tranche will remain open for subscription till November 2, 2016. The nominal value of these bonds was fixed at Rs 3,007 a gram. However, the government decided to offer a discount of Rs 50 per gram, so that the effective issue price works out to Rs 2,957 per gram.

The bonds will be issued on November 17, 2016. They will have a tenure of eight years and will allow exit from the fifth year. The interest rate has been reduced from 2.75 per cent earlier to 2.5 per cent of the nominal value.

The 25-basis point reduction in interest rate should not act as a disincentive for investors. “The reduction in interest rate merely reflects the decline in rates within the overall economy,” says Bhargava Vaidya, a bullion expert and proprietor, B N Vaidya and Associates.

The alternative, which is to invest in gold exchange-traded funds (ETFs), is worse since they offer no interest and also charge an expense ratio of around 1 per cent, and would therefore set you back by 350 basis points annually compared to sovereign gold bonds.

The bigger question is whether you should invest in gold now. Experts suggest you should invest if you have a horizon of at least five years. In the near term, a couple of factors could cause the price of gold to correct. “If the US Fed hikes interest rates in December, with the prospect of more hikes next year, that would cause a correction in the price of gold,” says Arnav Pandya, a Mumbai-based financial planner.

The second factor that could bring about a decline is a possible reduction in import duty by the Indian government. “A cut in the import duty would lead to an immediate downward adjustment in the price of gold,” says Pandya. The Rs 50 discount offered on gold bonds is being attributed to the government’s desire to compensate investors in advance for the fall in price that could be triggered by an import duty cut.

The price of gold will also be driven in the near term by the US election. “A Clinton victory would mean policy continuity and could result in a rate hike in December. But a Trump victory could produce uncertainty and delay the hike. Beginning from January 2017, the Brexit negotiations will begin and they will also contribute to uncertainty,” says Chirag Mehta, senior fund manager-alternative investments, Quantum Mutual Fund. Higher uncertainty is positive for gold.

According to experts, any long-term portfolio should have a 10-15 per cent allocation to gold, as it helps diversify the portfolio and brings down volatility. Given the continuation of quantitative easing in Japan and Europe, low to negative interest rates in many parts of the world, and competitive devaluations, an allocation to gold makes sense for all long-term investors.