Why some investors may give Sovereign Gold Bond Scheme a miss

Investors already having a sizable exposure to gold as an asset class could give the upcoming Sovereign Gold Bond Scheme offering a miss as the yellow metal prices have run up sharply in recent months.

Wealth managers believe investors should allocate 10-15% of their portfolio to gold because of the weakening dollar, geopolitical tensions, and slowing global growth. However, given the 51% rise in gold prices over the last one year and 11% in July alone, investors could avoid aggressive bets on gold, they said.

The Sovereign Gold bond scheme 2020-21- Series 5 opens for public subscription from August 3-7. Investors using the digital mode of payment will get a discount of Rs 50 and will pay Rs 5284 per gram. Those using the physical mode will have to pay Rs 5334 per gram. This is about 15% higher than the first tranche offered in April at Rs 4589 per gram.

“If you have a less than 5% allocation to gold, make some additions through the issue of sovereign gold bonds. However, if you already have 10%, and want to invest for the long term, don’t rush right now as prices have shot up sharply,” said Harshad Chetanwala, CFP, CoFounder, MyWealthGrowth.

Massive monetary easing, monetary relief packages, weaker dollar, and high liquidity could result in higher commodity prices, which in turn could spur inflation. Gold, known for preserving purchasing power, will become a preferred asset in such times.

“The US economy suffered its worst period ever in the second quarter, with GDP falling a historic 32.9%, jobless claims at a high and no signs of any relief from coronavirus. All this will continue to support gold prices,” says Anuj Gupta, Deputy VP (Research), Angel Broking. He believes domestic prices could jump to Rs 55,000 to Rs 56,000 per 10 gram in the next couple of months.

With the outlook for equities bleak due to lockdowns which will result in slowing growth and interest rates remaining low, more money is chasing gold.

“A quick rebound in economic activity seems unlikely in the near future. This will cap gains in equities and keep the increased investment demand for gold intact,” says Chirag Mehta, Fund Manager, Quantum Mutual Fund.
Chirag also believes central banks will continue to remain accommodative due to which bond yields and short-term interest rates are bound to stay low in nominal terms and negative in real terms for the foreseeable future. This in turn will limit bond markets’ ability to act as a hedge against equity price volatility and is positive for gold.

Wealth managers believe sovereign gold bonds should be the first choice for long-term investors looking to accumulate the yellow metal with an objective of holding until maturity. This is because there is no expense ratio, investors earn an annual 2.5% interest and these bonds are tax-free on maturity.

Compared to this, exchange traded funds (ETFs) have an expense ratio of 50-80 basis points every year and do not pay any interest, however they enjoy higher liquidity.

Sovereign gold bonds are best placed on the taxation front especially for HNIs as they do not attract capital gains tax if held until maturity. Compared to this, equities attract a 10% long term capital gains tax, while long term capital gains of debt funds are taxed at 20% with indexation. Even gold ETFs are taxed as debt funds.
Sovereign gold bonds have a tenor of eight years, with investors having the option to exit after the fifth year on interest payment dates. The redemption price will be the simple average of the closing price of gold on the previous three days.

In addition, they are traded on the stock exchange with investors having the option to sell anytime, though liquidity is low and in the past they have traded at a discount to the gold price.

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