This Dhanteras, many of us would be rushing to shops to buy gold. While bars and coins are very liquid, their purity is not always guaranteed. They have storage costs and come with issues of retailer mark-ups and lower resale value. That is the reason Gold exchange-traded funds, gold mutual funds and Sovereign Gold Bonds have become popular.
As per a recent Jefferies report, 15.5 percent of Total Indian Household Assets as of March 2023 are in Gold. Gold’s share is second only to Real Estate which accounts for 50.7 percent. Bank deposits (14 percent), Insurance funds (5.9 percent), Provident & Pension funds (5.8 percent), Equities (4.7 percent) and Cash (3.4 percent) make up the rest. With a Quantum Mutual Fund study concluding that a 10-15 percent portfolio allocation to gold is ideal from a risk-return perspective, it seems that Indians, with their affinity for gold, have got it right. The 10-15 percent allocation allows investors to lower risk without impacting overall portfolio returns.
Gold and the Indian household
Traditionally Indians have saved in gold by buying small jewellery or gold bars and coins which are later converted to larger wearables at opportune times like weddings or liquidated in times of financial needs. But with changing demographics, greater access to banking facilities, explosion of the digital economy, and increasing awareness about financial investment avenues that help them to get greater bang for their buck, consumer preference is slowly moving away from physical gold to digital avenues.
While bars and coins are very liquid, their purity is not always guaranteed. They have storage costs and come with issues of retailer mark-ups and lower resale value. As per the World Gold Council, Indian demand for gold bars and coins has slowed down in recent years.
Indian demand for gold bars and coins (tonne
On the other hand, Gold Exchange Traded Funds (ETFs) and Sovereign Gold Bonds (SGBs) which are the leading digital gold investment avenues in the country today are seeing growing acceptance. A Gold ETF is a passive investment instrument that invests in physical gold of highest purity and aims to track the domestic physical gold price. Generally, one Gold ETF unit is approximately equal to 0.01 grams of gold. The units are listed and traded on stock exchanges, offering the investor the flexibility of stock investment and the simplicity of gold investments.
The shift to digital gold
While Gold ETFs were launched in 2007, the bulk of the interest has come in post the outbreak of the Covid-19 pandemic when physical gold markets just like other areas of the economy were locked down, depriving investors the chance to liquidate their gold holdings for emergencies, when they needed funds the most. Since financial markets continued to function during the time, Gold ETF investors had an exit option which allowed them to liquidate their holdings during market hours at close to market prices. The number of investors in Gold ETFs has increased from close to 4.61 lakh in January 2020 to 48.06 lakh in September 2023. Assets under Management for this category as of September end stands at Rs 23,798 crores.
On the other hand, Sovereign Gold Bonds are government bonds denominated in gold that offer investors market-linked returns on gold.
Both Gold ETFs as well as Sovereign Gold Bonds are suitable for long-term investment in gold and score above physical gold (laden with purity concerns, storage issues and price inefficiencies) as an investment avenue.
Also read: Should you pledge gold to invest in equities?
Does gold add value?
From a returns perspective, Sovereign Gold Bonds score over Gold ETFs because they pay a 2.5 percent annual interest and capital gains are not taxed if the bond is held till maturity. But there are several reasons why investors continue to invest in Gold ETFs. Some of them are:
Gold backing: Unlike Gold ETFs, SGB’s are not backed by physical gold. Many investors prefer the security of gold backing instead of a government guarantee. That is justified because gold’s value is derived from the fact that unlike equities and debt, it is no one's liability.
Flexibility to enter and exit: While investing in a SGB with the intention of holding the bond till its maturity and benefit from the capital gains tax advantage, the investor lands up taking a bet that gold prices will be up 8 years later at the time of redemption, which may or may not be the case.
For instance, gold prices may peak four years into the investor’s SGB holding period, but the investor will be unable to sell it and book profits. By the time maturity arrives, prices may have moved down again. Thus, you may have bought sovereign gold bonds to capitalise on the capital gains tax advantage but that will be helpful only if there are gains to be taxed. Although gold has historically given better returns over long time periods, there may be cycles where gold doesn’t perform. For instance, gold bought in 2011 didn’t have much capital gains in the ensuing 8-year period. So was the case for gold bought in the 1980s until the mid-1990s. This lack of flexibility is not only true for selling, but also relevant in case of buying. When gold falls and becomes attractive, there may not be an SGB tranche available for one to invest. In such cases one may lose out on a lucrative entry point for gold. This is not the case with Gold ETFs, where you can enter or exit at any point in time taking timely advantage of the price movements in gold to either build your exposure or book profits.
Liquidity at fair prices: SGBs have an eight-year tenure with an exit option from the fifth year onwards only. Tax benefits are only applicable if the bond is held till maturity, which limits liquidity in secondary markets.
Thus, SGBs are usually seen trading at a discount on the exchanges.
So, if an investor wishes to sell the SGB before the eight-year maturity, either for rebalancing or liquidity purposes, he may be forced to sell the bond at a discount in the secondary market which would eat into the investor’s returns, partly or fully offsetting the gains made from the 2.5 percent annual interest. In contrast, Gold ETFs are very liquid. Gold ETF units are traded on the exchange at the prevailing market price of physical gold; thus, investors can buy or sell holdings during market hours at close to the market price. Thus, from a portfolio perspective, Gold ETFs are more efficient.
Regular investments: Investors who do not have a demat account can choose to invest in Gold ETFs through Gold Fund of Funds. These mutual funds enable them to opt for a Systematic Investment Plan (SIP) and regularly invest in this strategic asset class without having to worry about timing the market.
No investment limit: Unlike SGBs which have an annual investment limit of four kgs for individual investors, Gold ETFs have no restrictions on investments.
To sum it up, Sovereign Gold Bonds can be a good gold investment avenue for the long term, but if the comfort of physical gold backing your gold investment, liquidity at close-to-market prices and ability to SIP are important to you, Gold ETFs can be a better choice.
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