Sovereign gold bonds: Buy gold as inflation hedge, not for tactical play

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The ongoing Russia-Ukraine war has pushed gold prices to a 13-month high in the global market to $1,908 per ounce on February 23, and in the domestic market, prices rose to Rs 52,228 per 10 grams at MCX spot, indicating the yellow metal’s appeal as a safe haven during times of crisis. With equity and crypto markets remaining volatile and vulnerable to the geo-political developments, the metal will benefit as risk-averse investors increase exposure to it amid pullbacks in riskier assets.

The government has also launched the Sovereign Gold Bond (SGB) Scheme 2021-22 – Series X, which will be open for subscription till March 4. The Reserve Bank of India has set the price at Rs 5,109 per gram of gold. Investors applying and paying online will get a discount of Rs 50 per gram.

However, gold has come off the highs as risk sentiment stabilised after market players assessed the impact of sanctions by US and other western countries on Russia. Experts say once the uncertainty eases, gold prices would tend down as has been the case in the past. In the domestic market, gold prices rose 8.5% since January this year. So, should individuals invest in gold as a portfolio diversifier and a hedge against inflation?

Risk-reducing role

Chirag Mehta, senior fund manager, Alternative Investments, Quantum AMC, says while the Russia-Ukraine conflict will be in the headlines for some time now, investors should remember gold is not a tactical play. “One should stick to the fundamentals and allocate 10-15% of their portfolio to this strategic asset class which has time and again played a return-enhancing and risk-reducing role in investor portfolios in times of financial, geopolitical or other crisis. Those already invested, should thus stay put. New investors should avoid lumpsum investment at current levels,” he says.

What to buy

Though most Indians prefer to buy gold jewellery—data from World Gold Council show gold demand for jewellery was up by 93% at 610.9 tonnes in 2021 as compared to 315.9 tonnes in 2020—it is not the same as investing in gold because physical gold is stymied with price inefficiencies through markups and making charges which affect the returns. Then one has to be particular about the purity and hallmarking, besides the cost of storage as in locker rent.

Investments in gold should be done in the financial forms—Sovereign Gold Bonds and gold exchange traded funds (ETFs). While digital gold sold through wallets or non-broking platforms meet the liquidity criteria, they fall short on regulation and price efficiency due to high bid-ask spreads.

Sovereign Gold Bonds

An investor can buy SGBs digitally through the websites of scheduled commercial banks, bank branches, designated post offices, National Stock Exchange and Bombay Stock Exchange. Though SGBs pay an annual interest rate of 2.5% payable semi-annually and are tax efficient because there is no capital gains tax if held till maturity, they suffer from low secondary market liquidity resulting in price inefficiencies. An investor will have to hold the bonds for eight years and will have an exit option from the fifth year which can be exercised on the interest payment days.

Gold ETF

Gold ETFs sold by mutual funds are backed by 24-carat physical gold and investors do not have to worry about purity or storage. They are open-ended funds and are traded on the exchange at the prevailing market price of physical gold. One can buy a gold ETF by investing an amount as low as Rs 50 and the transaction can be executed at any time during the trading hours. The returns are benchmarked on the real returns on physical gold, subject to tracking errors. There are no deductions, expect for exit load for a particular period holding.