Sovereign gold bonds or ETFs, which is the better gold investment?

  • Both are well-regulated instruments, far better than the physical mode of holding gold
  • SGBs score hands down on returns with regular interest, no expenses and better taxation at maturity
  • Both liquidity of and taxation on SGBs  are negatives if you cash out before maturity
  • Use SGBs for your long-term gold allocations and add gold ETFs during market dips

In an earlier article, we had suggested that having a 5-10% allocation to gold in your portfolio is a good strategy if you’re an Indian equity investor wanting to hedge against unexpected downside. But what is the best way to acquire this gold exposure?

Buying physical gold both in jewellery and coin/bar form is avoidable in India because of quality issues and the lack of liquidity.

Sovereign Gold Bonds (SGBs) issued by the RBI on behalf of the Centre and Gold Exchange Traded Funds (ETFs) are more efficient paperless modes to invest in gold in India. But how do they stack up against each other?

Ease of buying

Gold

SGBs are issued by the Government of India through limited period offers that open 6 to 7 times a year. Each SGB series is usually open for 5 days, when they are available through commercial banks, the stock exchanges, stock brokers and designated post office branches. You can apply either through electronic or physical mode. Allotment is typically completed within 5 days. The bonds can be held in demat form or through physical certificates. The minimum investment is 1 bond, which represents one gram of gold and the maximum capped at 4 kg per fiscal year.

Gold ETFs offered by mutual funds are available through the stock exchanges like shares and require a demat account. One ETF unit may represent one or half a gram of gold. AMCs offer open-end fund of funds that allow you to invest in gold ETFs without a demat account, but they carry an extra layer of costs towards AMC management fees, which can eat into returns.

If you are looking to time your gold purchases to declines in gold market prices or acquire your gold holdings through monthly SIPs, gold ETFs are more convenient than SGBs. Buying SGBs in primary offers requires you to hold cash awaiting an offer and the offers aren’t particularly well-timed to lows in market prices of gold.

SGBs once issued are listed and traded on the stock exchanges and can be bought from the secondary market too. But trading volumes are thin for most SGB series. Because each series of SGBs carries a different maturity and interest rates (earlier tranches offered 2.75%, recent ones offer 2.5%), it can be difficult to identify the right SGB to buy. At the time of writing this, the quoted prices of SGBs (each representing one gram of gold) varied from Rs 3750 to Rs 4000. You will need to familiarise yourself with the interest rates, maturity dates, volumes, and quoted price of each SGB series, to home in on the one that is the best option.  

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Returns

In terms of returns, SGBs score over gold ETFs hands down, on three counts. One, in SGBs apart from the capital appreciation (or depreciation) in the price of gold, you get to earn a half-yearly interest on your holdings. Recent tranches pay interest at 2.5 per cent per annum on the nominal value of the SGB (which is based on the gold price at the time of the offer). In gold ETFs, your only return comes from appreciation (or depreciation) in the price of gold during your holding period.

Two, while gold ETFs charge an annual expense ratio of 0.40-0.80 per cent a year, SGBs carry no such costs, adding to your returns.  

Three, while buying/selling gold ETFs from the market, the premium/discounts in market prices against NAV can dent your returns. In SGBs, if you buy in primary offers and hold till redemption, you get prevailing market prices of gold. 

Liquidity

Every series of SGBs has a fixed maturity date set eight years from the date of the issue and is redeemable at the prevailing price of gold at maturity date. Early redemption is allowed via RBI after the completion of the fifth year, with the redemption value set at the average closing prices for the previous 3 working days. But early redemption proceeds will only be paid on the interest payment dates of the SGB. Investors seeking exits from SGBs at other times will need to take the market route to sell their holdings. But this may be hampered both by low trading volumes and SGB market prices trading away from gold prices.

Of the 35 distinct series of SGBs listed and traded on the NSE while writing this, 9 registered no trading volumes on the day we took stock, 23 saw a traded value of less than Rs 1 lakh for the entire day and only one series saw a traded value of over Rs 10 lakh.

Of the 35 distinct series of SGBs listed and traded on the NSE while writing this, 9 registered no trading volumes on the day we took stock, 23 saw a traded value of less than Rs 1 lakh for the entire day and only one series saw a traded value of over Rs 10 lakh.  The thin volumes effectively mean that you may have to wait for several days/weeks to liquidate your SGBs if you have a sizeable portfolio allocation to them. This may impede your ability to time your exit from SGBs to a spike in gold prices, or to quickly encash them in case of financial need.

Gold ETFs are more liquid than SGBs. Of the 11 gold ETFs that are currently listed, every one was traded while writing this. But of these, only two ETFs registered low trading value of just about Rs 1 lakh for the day (Birla Sun Life and Invesco Gold ETFs), five reported traded value of Rs 5-10 lakh (IDBI, Quantum, UTI, Axis and ICICI Pru) and four registered traded value of over Rs 50 lakh for the day (Kotak, HDFC, SBI and Nippon Gold Bees). Nippon Gold Bees was the most actively traded. 

Investors may be better off sticking to the highly traded ETFs for better liquidity and less price distortion relative to NAV.

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Taxation

SGBs offer a better deal on the taxation front. If you buy SGBs and hold them till their maturity of 8 years, the proceeds are completely exempt from capital gains tax, as a special dispensation. But if you sell them in the market or after the 5-year lock in, the gains you make are taxable as capital gains. The gains will be taxable at your slab rate if your holding period is less than 36 months and at 20% with indexation benefits for holding longer than that. The capital gains tax exemption on maturity is only available to individuals. The interest you receive on SGBs is taxable at your slab rate.

SGBs offer a better deal on the taxation front. If you buy SGBs and hold them till their maturity of 8 years, the proceeds are completely exempt from capital gains tax, as a special dispensation.

Gains on Gold ETFs are treated as short term capital gains and taxed at your slab rate if you hold them for less than 36 months. They are treated as long-term gains and taxed at 20% with indexation benefits if held for over 36 months.    

Our take

So, given that SGBs and gold ETFs have their own pros and cons, which should you go for?

  • If you are accumulating gold towards a long-term goal such as a family wedding or a constant passive allocation in your portfolio, SGBs offer a better deal with low costs, better returns and friendly tax treatment at maturity. You can invest in SGBs as and when their primary issues open up. At this point, the lack of liquidity in the secondary market makes it a tricky route for investors unfamiliar with gold prices to identify the right SGB series.
  • You can supplement the long-term SGB investment through one-off gold ETF purchases when sharp declines in gold prices offer a buying opportunity.  
  • If you want to make monthly investments like an SIP, then go for ETFs. This also makes sense make you are using gold as part of your asset allocated portfolio.
  • When gold present opportunities to buy, we will come up with a call on when to invest and which instrument to invest in.

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11 thoughts on “Sovereign gold bonds or ETFs, which is the better gold investment?”

  1. Why you have not compared the SGB & ETF with Digital Gold. In Case of SIP, someone can always go for digital Gold. What are your views on same?

    1. Aarati Krishnan

      As digital gold is offered by brokers, it is not as well regulated as ETFs or SGBs. In ETFs there are audits to check if the units are backed by physical gold. No such checks in digital gold.

      1. Thanks alot. What about purchasing Digital gold from Banks (SBI/ICICI – I am an Investor in SGB and notin Digital Gold).Whether that would be audited or they are also selling it on behalf of some broker?

        1. Aarati Krishnan

          Banks offer physical gold, imo, and not digital. Buying gold bars/coins from banks takes care of purity issues but not the liquidity as banks don’t buy them back. If you came across a digital gold offer from a bank kindly share it here so we can look at it. Thanks!

  2. Prakash Verma

    Nice article . One query, if i want to accumulate gold for long term say for 20 years for consumption, SGB looks good it will automatically be matured after 8 years at that time’s market price, even if I want to retain it. What is the way to retain it for longer period?

    1. Aarati Krishnan

      That’s a good query and unfortunately SGBs today don’t allow such holding. You may need to keep track of maturity dates and invest the sum in a new tranche before the old one matures so that you can continue the investment. Buying gold ETFs for same value is an alternative if SGBs not available.

  3. Santosh Gokak

    Thanks for a well written article. I recently bought into SGB series 8. I guess I got it at the peak of the cycle. As mentioned by you towards the end of article, I will wait for triggers from you to add it further.

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