With the global uncertainty rising in the light of the trade war and the rising geopolitical risk in the Middle East, there is an increasing demand for gold as an asset class. Gold is normally known to hold value better in uncertain time and that is evident from the way gold prices have moved in the last few months. Check the chart below.
Chart Source: Bloomberg
As the chart above depicts, the spot price of gold in the global markets has moved up by nearly $200/troy ounce during the last year. The moot question is how to participate in this gold story. Broadly, there are different ways of holding gold. You can hold gold in the form of gold bars, gold coins, and gold bonds or as gold ETFs. While gold bars and gold coins are all about gold in physical form, gold bond and gold ETFs are about holding gold in the form of securities. Let us look at a comparison of investing in gold bonds versus gold ETFs.
Gold bonds versus gold ETFs
Gold demand is a function of consumption and investment needs. Consumption demand is largely in the form of jewellery and to a lesser extent in the form of industrial demand. Investment demand comes from the need to diversify and hedge your portfolio in turbulent times. Gold is stable asset class and does not lose value easily. On the contrary, gold actually does very well when there is global uncertainty as we have seen in the midst of the Lehman crisis and more recently in 2016 when the global equity markets corrected sharply in response to the first rate hike by the US Fed in 10 years.
Holding investment gold in physical form has a plethora of challenges. Maintaining physical gold is cumbersome and you have to bear loss of value each time you reverse your transaction. Physical gold needs to be stored safely and you also need to insure it. Transferring gold physically is also difficult since there is no ready secondary spot market. That is where gold in the form of securities comes in handy. You can hold gold securities either in the form of gold bonds or gold ETFs.
Both gold bond and gold ETFs can be held in your existing demat account. Gold bonds can also be held in the form of physical certificates. The similarity between gold bonds and gold ETFs is that their performance is linked to the price of gold. That is where the problem of choice comes in. Should you opt for gold bonds or gold ETFs? The answer would depend on what exactly is your need at the current point.
Making a choice of gold bonds versus gold ETFs: what logic to use?
The decision on gold ETFs versus sovereign gold bonds can be predicated on the following factors. You can make the choice based on what suits your needs best.
- How do they compare on returns. Here, sovereign gold bonds have an edge over gold ETFs. Gold ETFs are like a closed ended mutual fund and so the management and other expenses will be debited to the gold ETF NAV. This is part of the TER that gets proportionately debited to the fund. This reduces returns. The sovereign gold bonds are issued at a discount to the market price and you get a still lower price if you apply online. Sovereign gold bonds also pay annual interest of 2.5% currently. So, purely in return terms, gold bonds surely score over gold ETFs. In terms of risk, both are roughly similar.
- If you are planning to hypothecate gold and take a loan, the Sovereign Gold Bonds are a better choice. Gold ETFs cannot be pledged as collateral with bank for a loan while getting loans against the gold bonds is a lot simpler.
- Gold bonds also have an edge in terms of taxation of capital gains. Here is how they differ. In case gold bonds are held till maturity, there is no capital gains tax. Gold ETFs are subjected to STCG tax if held for less than 3 years and LTCG tax if held for more than 3 years. A word of caution here. If gold bonds are not held till their date of maturity, they are also subjected to capital gains tax.
- If you really wonder as to where gold ETFs really score, it is in the ease of entry and exit. Gold ETFs can be bought and sold in the secondary market like any other share and goes into T+2 rolling settlement. Gold bonds are only available at intervals when issued by the RBI and the redemption can happen from the fifth year only.
- Gold ETFs also score on secondary market liquidity. It is possible to buy and sell fairly large quantities if Gold ETFs in the open market. Liquidity is an important factor that works in favour of gold ETFs.
To encapsulate, while gold ETFs score on liquidity and ease of entry, gold bonds score on returns and tax efficiency. You can make a choice based on what suits your needs best!