Why Physical Gold No Longer Makes For A Good Investment For Retail Investors 

Since 2002, gold has yielded positive returns for Indian investors in all but two years. The average annual return has been 12.9 per cent in rupee terms, and the only two exceptions – when gold lost value – were 2013 and 2015, when returns fell by 18.7 per cent and 5.9 per cent.

However, we need to rethink our attachment to physical gold, especially since the government – against most norms of fiscal sense – is planning to give us positive returns over and above what we get by way of market price changes.

Gold has always been of emotional interest to Indians. This is because it has shown two key characteristics: one is its obvious utility as jewellery, where it is a part of marriage gifting to the bride. The other reason is that it has held its own against inflation. While paper money tends to lose value over long periods of time, gold prices have given positive returns over inflation. This is why Indians hoard gold.

However, a subtle change has occurred in the gold market after the government decided to offer sovereign gold bonds for subscription by individuals. While those who want physical gold for jewellery purposes will continue to buy the yellow metal, the logic of buying the yellow metal for investment is now debatable.

Sovereign gold bonds are now safer than physical gold. They cannot be stolen. You don’t need a locker to hold the metal. Also, physical gold loses grammage whenever it is melted and converted to jewellery. Your gold merchant may cheat you, but your gold bonds are guaranteed by government.

Secondly, these bonds bear tax-free interest of 2.5 per cent (earlier it was even higher at 2.75 per cent). And, third, the capital gains you get at the time of redemption (after eight years, unless you sell in the secondary market), are tax-free.

Last month, the Modi government made more changes to the scheme, and allowed individuals to buy upto 4 kg per financial year, eight times more than earlier. This means those who want to buy gold more for investment than just jewellery, can now do so.

This should substantially change the dynamics of the gold buying tendency among Indians.

First, those who buy gold for investment purposes can do so through the paperless route. The investment is safe, earns annual interest-free returns, and the capital gains are tax-free. Capital gains on physical gold are taxable after three years at 20.6 per cent, after indexation for inflation. This is similar to how debt mutual funds are taxed. When sold within three years, capital gains on physical gold will be taxed like income at your tax bracket.

Second, sovereign gold bonds are now superior to gold exchange-traded funds (ETFs), the earlier form of paperless gold holdings that investors were getting used to. Gold ETFs also attract capital gains taxes like physical gold, since ETFs are supposed to buy physical gold against investments.

Third, at 2.5 per cent tax-free, returns on sovereign gold bonds should now be compared to tax-free bonds, where current market yields are in the range of 6 per cent for maturities stretching to 10-20 years. If we add the capital gains possible on gold bonds, real returns at the end of any eight-year holding period may well be comparable to tax-free bonds issued by public sector companies. Of course, you need some luck here, for the eight years in which you invest may be a bearish period for gold, but then that is true for all gold investment. If the record of gold indicated at the start of this article is any guide, we can assume that there is a good chance that gold bonds will beat tax-free bonds.

Fourth, even those who want to buy physical gold for marriages, will benefit from sovereign gold bonds. Families know when they will need to buy gold, and so if the idea is to gift gold to your daughter 10 years from now, you can invest right now and collect the money at the end – and all tax-free. You can buy the physical gold with the money redeemed, since the redemption price will be at the market price on that date. Even if the value of the bond falls, the market price of gold would have fallen by a similar amount, and hence there is no loss to you.

With the government increasing the amount of gold you can buy annually, and with these bonds being listed on the stock exchanges, early exit is also possible.

Gold’s attraction as an investment has improved, even as the attractiveness of holding physical gold has reduced. While Indians will not easily give up gold, since they have an emotional attachment to it, this writer believes that the rationale for holding too much physical gold is falling. Sovereign gold bonds are a winner.

(A modified version of this article was first published by Dainik Bhaskar)