In simple words, government sovereign gold bond scheme is where instead of having physical gold sitting idle in your house, you can invest in gold bonds.
These gold bonds are in demat form, and unlike physical gold gives you an interest of 2.75% annually additional to whatever appreciation happens on the underlying gold value. This interest payment is half yearly on 30th May and 30th Nov.
What happens if gold value drops?
If it drops, your value of gold bond also drops. It is the same way like the value of your gold jewellery also drops if gold prices come down.
The first tranche of sovereign gold bonds that were issued Nov 2015, is available for trading from June 13,2016 .
What this means is that you can now invest into them on the exchanges. So from June 13th, you and me can also buy these bonds from the market like we buy stocks.
These bonds will give you an additional 2.75% interest for the holders, so it definitely makes better sense to buy compared to gold ETF's/MF's. Also these bonds are backed by the government, so there is sovereign guarantee.
It is important to note though that the gold bond prices on the exchange will be including the dirty price. Dirty price is essentially the accrued interest. The day interest is paid out by the government, the value of the bond will reduce by that amount (similar to how dividends work on stocks).
Let me try to explain dirty price in layman language, Assume you bought a bond at Rs 1000, with fixed interest of 12%. At the end of 1 month there is 1% interest accumulated, so the value of bond will automatically become 1010 (1% of 1000). If the interest is paid out monthly, as soon as the bond pays off this Rs 10 interest, the value of bond will drop by Rs 10 and go back to Rs 1000. So this Rs 10, which was the accrued interest is called the dirty price.
Now it is to be seen if trading in gold bonds become popular on the exchange or not. It may not make sense to participate if the bid/ask spreads are too big.