Why bonds are better than physical gold

Annual interest, absence of making charges make bonds attractive

For retail investors interested in buying gold bonds this Diwali season, the first roadblock has already come. While the government has set the bond price at Rs 2,684 a gram, gold prices have fallen sharply since the launch. At present, gold prices are at Rs 2,575 a gram, a sharp drop of Rs 109 a gram or 4.06 per cent.

No wonder, jewellers are already telling customers that putting money in paper gold – gold bond – might not be the best of ideas. “Entering at a loss in a product is something that most investors do not like. And that is what the jewellers are playing on,” says an industry observer.

However, investors should not get carried away with these statements. For multiple reasons. One, though the price of physical gold is down, it does not mean much benefit for the buyers of gold coins. The reason: if you were to buy coins from banks or jewellery shops, you would have to pay a premium for ‘making’ the coin. That is, buying a two-gram gold coin from State Bank of India (the smallest size it sells) would cost Rs 5,642, excluding value-added tax and any other local tax. That translates into a per-gram cost of Rs 2,821, much higher than the price of physical gold. Similarly, charges in places such as Titan would be 8-10 per cent above the price of physical gold.

Another important advantage is the interest the government will pay on gold bonds – a good 2.75 per cent on the initial investment or Rs 63.50 per gram. Of course, the main crib from investors is that this amount will only be paid on the initial investment price and not on the rising price of the bond. Say, the gold price goes up to Rs 5,000 per gram, the annual interest rate paid to bond investors would fall to 1.35 per cent. However, since the physical gold will not earn any interest, investors can consider bonds. Market experts, too, favour gold bonds now. “Even if physical gold is cheaper by four per cent, gold bonds are still a better choice as consumer gets 2.75 per cent per annum interest income. In the physical market, as you actually buy gold coin, you end up paying higher making charges,” said Jayant Manglik, president, retail distribution, Religare Securities.

In addition, gold bonds can be used as collateral for loans as well. While the guidelines of the same have not been announced yet, it will make the product liquid if investors can raise money on them. While capital gains treatment will be the same as physical gold for an individual investor, the Department of Revenue will consider indexation benefit, if bond is transferred before maturity, and complete capital gains tax exemption at the time of redemption, says a government press release. If the last two issues are pro-investor, bonds will score much better than physical gold and be a good choice for gold investors.

Applications for gold bonds are being issued from November 5 and investors can apply till November 20. Bonds will be issued on November 26.