Design Credits: Rakesh Mohan
There is a view that sovereign gold bonds will adversely affect the growth trajectory of gold exchange-traded funds (open-ended funds traded on stock exchange) in India. While it is premature to arrive at such a conclusion, the fears are not entirely unfounded, according to some analysts. Before any opinions are formed however, it would do well to understand the significant differences between bonds and ETFs.
Gold ETFs
Gold ETFs passively track the price of physical gold. Gold ETFs are, therefore, mutual fund units, which offer returns in tandem with gold prices. The value of one unit (NAV) is equivalent to 1 gram of 0.995 purity gold (approx) which changes in line with gold prices. Gold ETFs entail brokerage costs besides expense ratio which is deducted from the invested amount in that the returns may be less than the increase in the price of gold.
However, of late, the falling prices of gold have led to a decreasing demand for ETFs. For instance, the Assets Under Management (AUM) for gold ETFs (domestic) decreased from Rs.12,000 crore in the month of January 2013 to Rs.6,688 crore in May 2015. According to reports, demand for the yellow metal as an investment has been on the decline for the past two years globally.
Sovereign Gold Bonds
Investors can invest in the precious yellow metal on paper, courtesy the Sovereign Gold Bond Scheme which has a lock-in-period of 5 to 7 years. Sovereign bonds issued by RBI (on behalf of the government) are denominated in grams. The minimum denomination permissible is two grams while the maximum is 500 grams. One of the biggest advantages of sovereign gold bonds is that investors not only get the market price of the yellow metal at maturity but also an annual interest of around 2.75%. In case the price of gold plummets, investors can extend the bond scheme by three years.
Resident Indians and entities, HUFs, charitable institutions and trusts can buy bonds. Upon maturity, bonds are redeemable in paper currency. The principal is redeemed at the current price of gold (as calculated by India Bullion and Jewellers Association). Bonds which are sold via designated post offices and banks can be used as collateral by investors for loans.
Gold Bonds Vs ETFs
The differences between gold bonds and gold ETFs are listed in the table below:
| Feature | Gold Bonds | Gold ETFs |
| Capital appreciation | Yes
|
Yes (Investors can earn only the difference in the buying and selling rate) |
| Interest rate | 2% to 3% p.a in form of Gold | No |
| Guarantee | Backed by sovereign guarantee | Backed by Gold |
| Safety | Issued by Government of India | Managed by fund houses |
| Brokerage | No | Yes |
| Commission | 1% (government gives commissions to distributors) | Yes |
| Lock-In Period | 5 to 7 years | No |
| Expense Ratio | No | Yes (1%) |
| Taxation | 1. Capital Gains
2. Income from Other Sources are applicable
|
Short term capital gains and long-term capital gains tax is applicable |
| Loan Facility | Available | Unavailable |
| Payment Mode | 1. Cash
2. Cheques |
1. Cheques
2. Cash 3. Online transfer |
| Market | Commodity exchange | Stock exchange |
| Form | Paper, Demat | Demat account only |
| Liquidity | Low | High |
| Accessibility | Post offices and banks (accessible to small retail investors in villages and towns) | Online (High net worth individuals) |
Take your pick!
Gold ETFs are more liquid compared to gold bonds and can be managed from the comfort of your home. Also, buying gold ETFs is easier if you have a Demat account. However, while both Gold bonds and ETFs track the price of gold, the returns – specifically the benefit of interest pay-outs may tip the scales in favour of the bonds returns on ETFs depend on the change in gold prices. You should carefully weigh the pros and cons of both sovereign gold bonds and ETFs to choose the one most suitable for your financial requirements.