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Is Paper Gold a Better Investment Than Physical Gold?
Wed, 26 Oct Pre-Open

Indians are probably one of the most steadfast savers in the world. Just look at our love for gold. There's so much of it held in private hands - stashed away by the country's housewives and other private owners. Over the years, India has managed to accumulate around 20,000 tonnes of gold in jewelry, coins and gold bars!

However, the interesting bit is there isn't much gold production in India. We import almost all of it. This further puts pressure on our trade balance. Also, the imported gold isn't put to productive use in the economy.

Thus, it is in the government's interest to try and change our behaviour towards gold. They would love it if citizens chose financial assets over gold. The latest attempt by the government in this regard is the Sovereign Gold Bond (SGB).

The reason we come up with this topic today is the ongoing issuance of SGBs under the sixth tranche. The sixth tranche of SGB opened on Monday and subscriptions will remain open through to 02 November 2016.

The question comes as should one put one's money in the abovementioned sovereign gold bonds?

Before we answer that, let us first understand the characteristics of SGBs.

  • The SGBs are offered by the government in tranches. Anyone who wishes to buy them can do the same from post offices, banks, and the stock exchanges.
  • The bonds are denominated in 'grams of gold' (not in rupees) and every tranche is listed on the exchanges.
  • The tenure of the SGB is eight years with exit options in fifth, sixth, and seventh years. The bonds carry an interest rate of 2.5% in the sixth tranche (it was 2.75% in the previous five tranches), to be paid semi-annually.
  • The bonds carry a sovereign guarantee and at maturity, the owner of the bond gets the market rate of gold on that date.
  • There's no capital gains tax and no securities transaction tax applicable.

Under the sixth tranche, the government has decided to offer a discount of Rs 50 per gram. The bonds will be offered at Rs 2,957 per gram. This is the lowest price for SGB's so far this year.

The SGB appears to be a good option if your time horizon is five to eight years during which you can take the advantage of the 2.5% yield. However, the SGB cannot replace the need of physical gold in its traditional Indian role.

In our view, the SGB scheme is a worthwhile proposition while taking exposure to gold. However, what one must also keep in mind is that there is no point having an over exposure to such schemes. One needs to look at gold as a portfolio diversifier and as a monetary asset (rather than a mere commodity). It is an asset that can help in reducing the risk of the overall portfolio with its trait of being a store of value in times of uncertainties.

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