What's the best option to invest in gold?

General
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Indians love their gold. According to a World Gold Council estimate Indians held between 23,000 to 24,000 tons of gold, a majority of it with Indian households. Indians have an emotional attachment with the yellow metal, it’s a significant part of everything from weddings to festivals. For most Indians, gold along with real estate have been the most popular investment options with jewellery being the most common option.

Off late other options like Gold ETFs, Digital gold through various online platforms and Sovereign gold bonds are becoming popular. Courtesy of the recent spike in gold prices, ETF holdings of gold have reached an all-time high of over 24 tonnes. But most investors just think of access to gold as an investment option without fully realizing the advantages and disadvantages of each option.

So, in this post, I’ll briefly cover the various gold investment options, which will also let you know why SGB and followed by Gold ETFs/MF are the best instruments if you are looking at gold as an investment option.

1. Digital gold

This mode has become quite popular thanks to all the wallets and payment options. These apps advertise the fact that you can start investing in gold for as little as Rs 1. But are you getting a good deal? Let’s compare.

What most people don’t realize that when you buy digital gold a GST of 3% is levied, so straight away you are down by 3%. And then each provider will have his commissions and spreads. Here are the latest buy and sell prices on some of the popular platforms. For comparison, the spot price of gold as of Friday was Rs 5104 per gram.

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The total spread between buy and sell works out to anywhere between 3.5% to 7% depending on the platform you use. This is a terrible deal no matter how you look at it. And then there’s the question of safety. These digital gold platforms aren’t really regulated by anyone and assuming that something goes wrong, it is not clear what the recourse for investors is.

2. Sovereign gold bonds (SGBs)

Undoubtedly, the best way to invest in gold bonds and here’s why. When you invest in gold bonds, you get a 2,5% interest every year. You are getting paid for holding gold. And then you don’t pay any GST, commissions, expense ratios etc. Not just that, if you buy gold bonds during the issuance and hold till maturity of 8 years, you don’t have to pay any capital gains. And when you buy gold bonds online, you also get a Rs 50 discount, doesn’t get any better than this.

As for safety SGBs carry a sovereign guarantee - meaning they are guaranteed by the Govt of India. Doesn’t get any safer than that. And these bonds are listed, even though volumes are still picking up, you can still exit anytime you want.

3. Gold exchange traded funds (ETFs) and mutual funds

the only small disadvantage of SGBs is that the minimum investment is in multiples of 1 gram. So, if you want to invest smaller amounts, you can consider investing in Gold ETFs or gold mutual funds. These ETFs and mutual funds have share prices as low a Rs 45. But remember, you pay an expense ratio when you invest in gold ETFs, this ranges between 0.50% to 1%. But you can sleep well knowing that these products are regulated by SEBI.

4. Physical gold

This is the most popular option but also the most inefficient option. When you buy jewellery/bars as an investment option, you have to incur making charges, GST, and then you are bearing a risk when it comes to storing it. The other thing is liquidity, selling physical gold is not an easy task unlike gold bonds or ETFs.

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Regarding SGB also note that any selling before 8years will involve paying capital gains.

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Few important pointers are missing regarding the Sovereign Gold Bonds (SGB) -

  1. There is no real Gold backing the SGB. It’s only a Sovereign Promise. In the case of Gold ETF or Digital Gold, an equivalent amount of physical Gold bars are purchased and kept safe with your name and respective portion in their ledger. In the case of SGB, there is no physical Gold backing. Only a promise by the Govt. There have been many cases when Govt had announced something and then taken a u-turn. E.g. https://economictimes.indiatimes.com/news/politics-and-nation/centre-pays-rs-4-lakh-to-the-families-of-coronavirus-victims/articleshow/74626886.cms?from=mdr
    Regarding 2.5% interest, think like this - it’s not about you getting 2.5% interest, it’s about you are lending to Govt a loan at a mere 2.5% interest amount, which is much less than the market rate. One more thing, when SGB were launched, the interest amount was 2.75% and then slowly, Govt reduced it to 2.5% in next tranches. So 2.5% is not fixed given the current economic conditions.

  2. You invest in Gold as a hedge against the current financial and economic system or the Govt policies. Think of it as insurance. So if you are buying Physical Gold or Gold ETF, in case of a financial hiccup or inflation, you are sure that you can sell off Gold and encash it because Gold is an international currency. But in the case of SGB, you are hedging against the system by buying a promise (SGB) from the same system. In the true sense of diversification, this does not reduce your risk or diversifies your portfolio. Until you find someone who is willing to buy bonds from you, you won’t be able to liquidate it. I have personally found the trade volumes are so less that many times your order is canceled because there is no buyer or seller.

  3. SGB was launched by late hon’ble FM Arun Jaitley in 2015. So 2015+8 = 2023 is when the first tranche would mature and then only we would be able to see the complete course of a single tranche of SGB from inception to maturity and how investors receive payments .etc.

Please note that I am not against SGB. If one makes an informed and strategic decision about when to buy and sell and which tranche of SGB, it may be profitable. It’s just that an investor should be aware of what he is getting into.

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Giving my personal opinion.

So a guarantee by sovereign body is not enough? the example you have given on government taking back it’s word is not a relevant one, not even close, if one thinks so pessimistically we can also think government coming out and saying all the money in worthless now and they no longer guarantee or consider it’s existence.

I am not going to ask who is seeing gold is being bought and certifying it’s quality just because there is some scam in china. china gold fraud: China's biggest gold fraud, 4% of its reserves may be fake: Report - The Economic Times

Seriously? you won’t get capital appreciation at the end if there is any?

One can use these as collateral and take a loan if required.

Of course volumes are low in secondary but there is some improvement and a long way to go.

Not sure what you want to convey here but yeah let me give some brief history behind SGBs.
We are a trade deficit economy and gold(gems and precious metals) is our single largest second highest imported good after oil. As many use gold as investment government came out with sgbs so we can reduce importing of gold. To attract users buying sgbs government is offering fixed coupon along with capital appreciation if any.

SGB is the cheapest option and safest option to go for if someone want to invest in gold for medium to long term and also indirectly helping the country in reducing the import bill.

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It has to be a personal opinion only. Because Zerodha is just a stockbroker and not an investment advisor. Be very mindful of every word that being a representative of Zerodha you or anyone from the company speaks. Because it may go against Zerodha as per the SEBI rules. e.g. when Zerodha publishes a facebook or twitter post that SGB is ‘the best’ option, in legal terms, Zerodha is claiming it so and is marketing it, which it can’t. You guys need to be more careful and watch your tongue. Also this site is now being aggregated on Google News which only lists official sites, so there is a responsibility too.

Remember Demonetisation?

I had already covered it in detail earlier - China Gold Fraud - How safe are the Gold ETFs? - #17 by rupeshmandal

The answer lies in the question itself - “if there is any”. Need I say more?
8 years is a long period of time. Out of which 5 years are under lock-in. You can lose as well since it’s market-linked. This thread covers how volatile this yellow metal is over time. Should you invest in gold?

At least we agree on something.

When an investor is redeeming, or at the time of maturity, the Govt has to pay back the value of Gold at the time of maturity. Where is Govt obtaining the difference amount between the buy price and the maturity amount, if the price has soared? Has Govt. increased its Gold reserves with that SGBs investments? If buying SGB helps RBI increase the Gold reserves, then it is helping in nation-building and making the economy stronger. But there is no Gold backing in SGB so I am not sure about how it helps. In the first tranche launched in 2015 SGB received about Rs 260 Cr investments. Gold price has already more than doubled since 2015 as we speak and by 2023 when Govt has to pay back the investors, where would it fund it? Because there is no real Gold backing. Remember, Govt is also giving 2.75% annual interest on those tranches. These are the reasons I am enquiring.

It’s not about pessimism but seeking the truth.
And moreover repeating what I had mentioned before:-

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I have a few questions

  • As there is a 12.5% import duty on Gold and 3% GST, would it be better to invest in an international Gold ETF rather than an Indian Gold ETF? Is doing such investment under LRS legal?

  • Also, given the differential of around 15.5% in gold prices due to import duty & GST, why doesn’t this price difference reflect in the actual gold prices (other than for physical/digital gold)? For reference, gold prices for different types of gold as of 25th Oct 2020 -

    • Physical Gold - MMTC 10g Gold Coin on Amazon - 56,390 (5639 per 1g)
    • Digital Gold - 1mg Gold on Google Pay - 5.40 (5400 per 1g)
    • SGB - SGBAUG28V (had most voume as per NSE) - 4691 per 1g
    • International Gold Price - 1902.61$ per troy ounce (4516.46 per 1g with 1USD equal to 73.83INR)
    • International Gold ETF - 1 unit of GLD (2.92g) - 178.64$ (4511.51 per 1g)
    • Indian Gold ETF - 1 unit of GoldBees (0.01g) - 44.64 (4464 per 1g)

    In theory, the price of Indian Gold ETF should be higher than International Gold ETF due to the extra import duty but instead, it is cheaper. Why does this happen?

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Giving recommendations/tips, sharing research reports are incidental to stock broking business and brokers are allowed to share their views, many brokers gives trading tips also which is legal and allowed by regulators said that we at Zerodha won’t give any tips etc.

lets imagine you invested in etf or online gold, after 5 years gold rate remained the same, what is your return in this case, nothing but in sgb you would have earned at least 2.5% coupon every year so isn’t SGB a better option to invest in gold.

How it will pay to end users should not concern us because it is sovereign guaranteed and if govt defaulted then it will have much higher repercussions which are unimaginable.

Whole point of SGB is to avoid importing more physical gold.

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Poor response and lacks knowledge.

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Giving recommendations with a disclaimer is fine. Here, with Zerodha there is no disclaimer attached. Also, the other stockbrokers just put the recommendations on the table without any opinion. It may be correct. It may be wrong. The disclaimer supports it. It’s up to the investors now. Here, Zerodha is using the word ‘best’ option for SGB which is a superlative adjective and in legal terms a claim by Zerodha, which sounds like a verdict, which I am telling your team to be careful about. The choice of words, and how you present the facts without being biased. If this post had mentioned the pros and cons of each and let the investors decide whichever way they want to go, it would have been the right way.

SGB is also under lock-in for 5 years. Please remember that as well and the trade volumes in the secondary market are almost negligible. So, if you want to book profit and quit or exit to cut loss, you won’t be able to do it. If you see the drawdowns of Gold, you would find that it is more volatile than 2.5% annual returns.

It indeed is something we should focus on. Because the reserves Govt. has is the taxpayers’ money only. Also, if Govt. decides to print money to cover the deficit, like the US Fed has been doing, it furthermore puts the economy into stress, and the Gold price soars again. So as an investor I would like to be informed about how Govt is earning to pay back the investors.

As I mentioned before, if SGB was helping Govt’s to increase Gold reserves, it would have helped the Rupee currency become stronger boosting the Indian economy. It would have helped in nation-building. But it’s not the case. A large chunk of this yellow metal imports is still used for jewelry and ornaments as it is considered an auspicious metal in Indian culture i.e. personal consumption. The portion for Gold as an investment is anyway less. So, regardless of SGB or not, people would tend to buy jewelry. Now that the festive and marriage season has begun, please notice how Gold is being bought and used.

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I don’t want to drag it any more, personally I believe if one want to invest in gold then SGB is the right option but one want to use gold as hedge when everything (defaults, deep recessions, war) screws up then holding physical gold is the right thing.

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Sir, in investing at some point you need to trust someone.
If you are buying SGB, you need to trust govt
If gold ETF … u are trusting MF to pay you back (remember Franklin?)
If you are buying physical gold … Need to trust jeweler who sold you (multiple instances of lower quality gold sold with fake certificates)

If you don’t trust anyone of them … Keep everything in bank. But then u are trusting bank (PMC??)
Better to keep cash at home … but then again you need to trust govt (demonetization)

So choice is yours … whom to trust

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You are right. Trust is important. But always verify. It’s even more important. Otherwise, later you would be like - Mona, kahan hai sona…??

Regarding SGB, as I had mentioned about the true sense of diversification in order to reduce risks -

I do have some investments in SGB and my say is -

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There have indeed been instances when it has been considered that GOI breached the sovereign guarantee or was very close to breaching it.

  • The most famous example is the abolition of Privy purses. Even though the amount due was around 4 crores annually & it was guaranteed directly by the Constitution, the Govt of that time decided to do away with it. Nani Palkhivala summarizes that issue briefly (From 3:19 to 5:02)

  • SSNNL Bonds. This matter remains sub judice & doesn’t directly involve the central government (instead, a state government is involved). Here the interest liability is upwards of 12,000 crores (on the borrowing of 570 crores) as mentioned in an article. A separate article by Aarati Krishnan explains this issue well - Myth of sovereign guarantee.

  • The recent GST shortfall fiasco. Even though GOI shrugged off the responsibility of the shortfall on the GST Council and there was a political slugfest with accusations of a sovereign default, parallelly anticipating the shortfall will ultimately become GOI liability, well before GOI announced the extra borrowing of 1.1 lakh crore a week back, RBI had told banks that if they buy another 3 lakh crores of government bonds, those wouldn’t be needed to be marked to market (as mentioned in an article)

Most of them can be attributed to change in the policy outlook compared to when the sovereign guarantee was promised.

As per the 2019-20 RBI Annual report, a total of 9,652.78 crores (30.98 tonnes) has been raised through SGB (37 tranches) since its inception in November 2015 (Page 190). The gold price has appreciated around 80-90% since then (The price per gram was fixed at Rs 2684 in the first tranche whereas latest tranche had its price fixed at Rs 5051 per gram). Data about increase/decrease in gold prices in the recent past -

Gold_Price
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Hypothetical, even if all the money (9652.78 crores) was raised via the first tranche (which isn’t the case), even then the obligation on GOI would be approximately around 19,000 crores as per the current gold rate. Given that GOI raises over 40,000 crores on a weekly basis via auction of T-Bills (Issuance calendar for Treasury Bills) & Government securities (Issuance calendar for Government Bonds (G-Secs/GOI Dated Securities)), I don’t think GOI will have any issue in repaying back SGBs. Recently there have been auctions in which government securities have remained unsold but normally this doesn’t happen.

Also, if all else fails, RBI has gold reserves of over 650 tonnes, out of which around 100 tonnes have been added in the last 3 years (over 3 times more than total SGBs sold till last FY). Hence, even if gold prices go crazy, GOI does own the underlying asset and can just sell it directly to meet the obligations arising from SGB

But please keep in mind, these are all my speculations (more about this later)

GOI reserve isn’t only the taxpayer’s money. It has its own assets (around 17 lakh crores in form of land, equity, etc) and it is trying its best to raise money by selling them (Even though its disinvestment targets currently look unachievable).

But I agree that taxation is indeed a sweet spot for GOI, which it can tap into whenever it needs funds. The best example being the taxes on fuels (around 200% markup on the original price, with further hikes likely)

This website sheds some light on this -

The issuance of the Sovereign Gold Bonds will be within the government’s market borrowing programme for 2015-16 and onwards. The actual amount of issuance will be determined by RBI, in consultation with the Ministry of Finance. The risk of gold price changes will be borne by the Gold Reserve Fund that is being created. The benefit to the Government is in terms of reduction in the cost of borrowing, which will be transferred to the Gold Reserve Fund.

(ii). Bonds will be issued on behalf of the Government of India by the RBI. Thus, the Bonds will have a sovereign guarantee.

(xv). The amount received from the bonds will be used by Gol in lieu of government borrowing and the notional interest saved on this amount would be credited in an account “Gold Reserve Fund” which will be created. Savings in the costs of borrowing compared with the existing rate on government borrowings, will be deposited in the Gold Reserve Fund to take care of the risk of increase in gold price that will be borne by the government. Further, the Gold Reserve Fund will be continuously monitored for sustainability.

(xvii). The deposit will not be hedged and all risks associated with gold price and currency will be borne by Gol through the Gold Reserve Fund. The position may be reviewed in case ‘Gold Reserve Fund’ becomes unsustainable.

I am not aware if this original policy still remains in force or has been tweaked. But, if it remains the same, then it is indeed unlikely that the funds in the Gold Reserve Fund would be able to cover the price rise in gold since the first tranche of SGB. It is likely GOI will have to resort to some different method (like the speculations that I made above or something different) to meet the obligations from these bonds when they mature as GOI has explicitly assigned a sovereign guarantee to them.

I personally think, GOI meets its obligation towards investors by taking on more debt (I think this is how all governments in the world work). An example is NSSF (which manages PPF, NSC, SCSS, etc) which is around 17 lakh crores in size and is used for giving loans to FCI, NHAI, etc. In some cases, to service the first loan it has given, it gives another loan (Refer to the last paragraph of this article)

But if you are interested in a general breakdown of how GOI earns money, there is a graphic released with the Union budget which sheds light on that -

india-union-budget-2020-21-rupee-comes-and-goes
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The amount of gold reserve of a country cannot directly strengthen the currency of a country because we don’t use Gold Standard monetary system nowadays. As we use a fiat money system, interest rate differential dictates depreciation/appreciation of the currency in the long term under normal circumstances (This concept is explained briefly by Abid Hassan in this video)

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@Bhuvan Does SGB bought from the Secondary market receives 2.5% interest

Also, does it have capital gains exemption?

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Yes, you are eligible for interest even if you purchase SGB from secondary market.

There are differing views on this. We’re trying to get some clarity

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Don’t think so as one should hold for 8 years(till maturity) to get complete capital gain exemption, said that above 3 years one has to pay long teem capital gains ie 20% with indexation.

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Another forum member tried asking RBI about this and they got a reply stating that the matter was referred to the Government of India

Other people have also gotten similar replies -

https://twitter.com/soodstuti/status/1315618609746518016

In a follow-up tweet, it has been claimed that capital gain is exempt for individuals even for secondary market purchases of SGB

EkRcBoRU8AA-uwM
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Yes I think only SGB’s are better option when it comes to investing in Gold. Although SGB needs a high hit amount as it should be bought in multiples but anyone can do that as it is backed up by Govt. of India. For smaller investments you can go for MFs undoubtedly!

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No higher amount needed. You can buy 1 unit which is equivalent to 1gm gold…

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Are you from Germany or other European country? Because a period is used to separate decimal numbers in India.