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Sovereign Gold Bonds Are Back! Should You Invest?

by tavaga
Sovereign Gold Bonds Scheme 2020-21

 

While SGBs are available at an attractive price, investors must prefer gold ETFs for they don’t come with any sort of lock-in period.

By: Tavaga Research

Sovereign Gold Bonds Scheme 2020-21 

RBI has announced another issue of Sovereign Gold Bonds (SGBs), which started on 22 August, 2022, and will close on 26 August. 

Sovereign Gold Bonds Online

The price of the issue is fixed at Rs 5,197 per gram. However, the investors may avail a discount of Rs 50 per gram by applying for the issue online and making the payment against the application. Therefore, the effective cost comes down to Rs 5,147 per gram.

The bonds will be sold through scheduled commercial banks, Stock Holding Corporation of India Limited (SHCIL), Clearing Corporation of India Limited (CCIL), designated post offices and recognized stock exchanges, NSE and BSE. 

Sovereign Gold Bonds Meaning

Sovereign Gold Bonds (SGBs) are government securities mandated by the RBI and denominated in grams of gold. Sovereign Gold Bonds were introduced by the RBI in November 2015 as a substitute for holding physical gold. The sovereign gold bonds are issued by RBI on behalf of the government at a set issue price.

The price of a sovereign gold bond is calculated through an average of the closing prices of the 999 purity gold for the last 3 days set by the IBJA (Indian Bullion and Jewellers Association Limited).

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What are the Features of the Sovereign Gold Bonds?

1.Source of Income: The investor is assured of capital gains depending upon the market value of the gold at the time of maturity. Apart from the capital gains, the SGB investor earns a fixed rate of interest of 2.5% p.a. on the investment amount. The interest is credited to the bank account semi-annually.

2. Tenor: The SGBs have a fixed tenor of 8 years with premature redemptions permitted after the 5th year from the issuance date.

3. Risks involved: The sovereignty of the bond ensures no credit risk unlike other corporate debt and hence, the SGBs are only exposed to price risk if the gold price declines.

4. Eligibility: A person who’s an Indian resident as per the FEMA (Foreign Exchange Management Act), 1999 is permitted to invest in the SGBs. Individuals, trusts, HUFs, charitable institutions, and universities are eligible to invest.

5. Investment limit: The minimum investment will be one gram of gold for every person and the maximum investment for an individual and a HUF will be 4 kg.

6. Process of application: Banks and other designated financial institutions can provide an online application facility. For offline applications, banks, designated post offices, and agents can provide forms. The application form is also available on RBI’s website.

7. Taxation: The capital gains from the redemption of the SGBs (at the end of 8 years) are tax exempted but the interest is taxable as per the income tax slab. If an investor sells the bond before redemption then capital gains taxes are applicable. Short term capital gains tax (less than 3 years) is applicable as per prevailing income tax slab and long-term capital gains tax (if more than 3 years) is applicable either at a flat 10 percent or 20 percent with indexation benefits. 

Other Features: Short-term

  1. Guardians can invest on behalf of the minor, making the minor eligible to invest in the SGB.
  2. Investors applying online will be given a discount of Rs. 50 per gram.
  3. The sovereign gold bonds can be used as collateral for loans from financial institutions.

Advantages of buying the Sovereign Gold Bond Scheme 2020-21:

  1. Portfolio diversification: Negative correlation with equities and fixed income instruments makes gold an attractive form of investment.
  2. No credit risk: As the name suggests, the Sovereign gold bonds are sovereign in nature with government backing and hence there is no credit risk involved.
  3. Convenience: With no storage costs and the risk of holding physical gold, investing in Sovereign Gold Bonds is hassle-free.
  4. Taxation: Sovereign gold bond is the only debt product whose capital gains are tax exempted.
  5. Loan Against Bonds facility: The sovereign gold bonds can be used as collateral for loans up to 75% of the market value.
  6. Inflation Hedge: Gold tends to hold its value during the episodes of high inflation while the local currency loses its purchasing power making gold a good inflation hedge.

Disadvantages of buying the Sovereign Gold Bond Scheme 2020-21 Series 12:

  1. Lock-in: With a fixed tenor of 8 years, premature redemptions in sovereign gold bonds are only allowed after the 5th year of the date of issuance, until then no withdrawal is permitted. However, an investor can consider selling the bond on stock exchanges anytime if he/she holds the bond in a dematerialized form. The liquidity in SGBs is very low, and the investor could end up selling the bonds at a heavy discount
  2. Market Risks: Being a commodity, gold is exposed to price fluctuations and hence with a decline in gold prices, the capital gains can decrease.

Gold ETF v/s the Sovereign Gold Bonds

  1. Liquidity: While both the instruments are tradable on a stock exchange, the liquidity offered by the gold ETF is comparatively higher than the sovereign gold bond.
  2. Lock-in: There are no restrictions on the sale of Gold ETF units after purchasing them. The sale has to happen during stock market hours. In the case of SGBs, once allotted, there is a lock-in of 5 years.
  3. Collateral for loan: As mentioned above, the SGBs can be used as collateral for loans while there is no facility for loans against gold ETFs.
  4. Investment limit: In the case of gold ETFs, there is no maximum investment limit unlike SGBs, where the maximum investment limit is 4 kg for individuals.
  5. Return: Apart from capital gains, an investor also receives a fixed coupon of 2.5% on the initial investment in the SGBs. There is no interest/coupon on the gold ETF. An investor only benefits through the appreciation of gold prices.

Is Sovereign Gold Bond a good investment?

Analysts express optimism over the presence of gold in an investment portfolio under the current market conditions. With the fiscal deficit mounting and the countries expanding their balance sheets, central banks will look to increase their exposure to the yellow metal. 

Furthermore, with the uncertainty looming in the equity markets owing to recessionary fears worldwide, a moderate 10-20 percent allocation toward gold will not hurt the portfolio. Gold has also corrected from its record highs indicating a buying opportunity.

Gold offers diversification benefits and serves as an inflation hedge. SGB not only offers all the benefits associated with physical gold but also holds numerous advantages, which makes SGB an investment worth exploring.

The recent hike in gold import duty from 7.5 percent to 12.5 percent. This import duty hike will lead to high gold prices for end consumers. This may curtail the demand for gold and reduce discretionary spending on the yellow metal. Also, investing in the ongoing SGB issue makes sense, only if the bondholder is ready to bear the lock-in period of 8 years.

For investors who are not in favor of the lock-in period, must stick to gold ETFs which are also available at an attractive price.

How to apply for Sovereign Gold Bond Scheme 2022?

  1. Online: An investor intending to apply for sovereign gold bonds can apply online through the website of scheduled commercial banks or through the stockbroker
  2. Offline: An investor can also apply for the sovereign gold bonds by filling the application form issued by the RBI. Scheduled Commercial banks, Stock Holding Corporation of India Limited, Post offices, and other designated agents can provide the application form. The application form can also be downloaded from the RBI website.

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1 comment

Onkar Patil October 20, 2021 - 2:28 pm

Very well written blog. Agree with your points. SGB can be a good investmentz option which can provide 2.5% returns per annum. It also has a feature where you can trade your bonds in the stock market if you had bought them in the Demat. You don’t have to worry about the storage problem as we have to do for physical gold.

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