How attractive is gold as an investment option?

With India accounting for an estimated 40% of the total privately held gold in the world – how good is gold as an investment option? And, what is the best way to invest in gold?

In this article, we try to find some answers.

India’s fascination for gold

India imported $36.1B worth of gold in FY17. Precious metals formed the second largest item in the nation’s import bill in FY17 after energy.

This has been a cause for headache of the governments over the years, as it distorts the trade bill and affects economy.

To prevent this, government have been providing various incentives to reduce hoarding of gold. This has increased the attractiveness of gold as an investment option.

Source: smaulgld.com

Options available to invest in gold in India

You can choose to invest in gold in 4-5 different ways as described below.

#1 – Physical Gold

Gold Jewelleries

Indian households love investing in gold jewellery as gold provides a natural hedge against inflation. With ornaments forming the biggest expense head in Indian weddings, investing in jewelleries is often the most convenient route to save for children’s marriages.

One very common sight in middle class Indian households is to see mothers squirrelling jewellery to marry off daughter(s). In many cases, these jewelleries have been handed down through generations.

As an investment however, jewelleries are the worst possible way to invest in gold because of the following reasons:

Gold jewelleries include making charge, which is a cost, that reduces the effective value of the asset.
You need to maintain a bank locker for its safe-keeping, which is a recurring cost.
Selling physical gold attracts capital gains tax on the profits

Gold coins and bars

Buying gold coins or bars is a better option compared to jewelleries as it eliminates issue of reduction in value from impurities and making costs. The remaining challenges however, remain.

#2 – Gold ETF

Gold ETFs save you from the hassle of safekeeping of the commodity, making it an improvement over physical form of gold.

Although they are as tax inefficient as physical gold, attracting capital gains tax at redemption.

STCG is taxed at marginal rate of income tax, while LTCG is taxed at 20% of profits after indexation. More than 36 months is considered long term.

#3 – Sovereign Gold Bond (SGB)

GOI introduced SGBs through RBI as a way to prevent hoarding of gold (as it creates trade imbalance and affects the economy). SGBs have the following features:

These bonds are denominated by multiples in grams of gold. You can buy any amount starting 1gm to 4kg a year.
Tenor of the Bond is 8 years with exit options in 5th, 6th and 7th year
Investors will receive an interest of 2.5% per year paid semi-annually
While the interests are taxable, capital gains arising from redemption of the bonds are tax exempt
Both issue and redemption happens at prevailing market price (determined as simple average of last 3 business day’s closing price quoted by IBJA for 999 purity gold)

The best part of SGB is that is that you get paid for holding paper gold without missing-out on the price appreciation. Besides, capital gains are exempt from tax.

SGBs are issued by RBI on behalf of GoI in tranches. At the time of writing, the next 5 issues are scheduled as follows:

You can contact your bank if you wish to invest. This is a much better investment option compared to physical gold or ETF.

#4 – Gold Monetization Scheme/ Revamped Gold Deposit Scheme (R GDS)

Instead of shoving your gold away in lockers and paying the banks for its safekeeping, you can deposit your idle gold against R-GDS and receive interest payments.

In R-GDS, you deposit your idle gold to banks, in the form of raw gold i.e. Gold bars, Coins, Jewellery excluding stones and other metals. Bank will melt it and issue you a Gold Deposit Certificate (GDS). Note that your gold will be immediately melted and put to productive use, so do not deposit any jewellery having sentimental value. Other key features are:

Minimum deposit quantity is 30 gm
Deposits can be short (1-3y), medium (5-7y) and long term (12-15y)
Medium & Long term deposits carry interest rates of 2.25% and 2.5%. Short deposits carry 0.5-0.6%
Both interests and capital gains are exempt from tax

Example: How to invest in gold for your daughter’s wedding – the right way

Let’s say you wish to present gold worth 20L at today’s value to your daughter for her wedding 20 years from now.

At 5% inflation, value of jewellery would be worth 20*(1+0.05)^20 = around 53L at the time of wedding

Let’s say nominal rate of return for gold is 9% and LTCG after indexation is 5%.

Traditional investing
If you are investing in physical gold or ETF, you need to invest 53/(1+0.085)^20 = 10.4L today

Investing in R-GDS
Alternatively, if you invest 7.5L in gold deposits today, then you will have 2 income streams, both tax free:

Capital appreciation = 7.5*(1+0.09)^20 = 42L

Interest receipts, re-invested in gold deposits at 2.5% = 18,750 yearly (or 9375 half yearly) paid for 20 years and re-invested = 10L future value

Total receipts = 52L

As you can see: investing in the old fashioned way increases your initial capital requirement by 38%. Also, the second option is much more hassle free.

Conclusion

If you look at the last 30-35 years of data, raw Gold as an asset class has performed better than fixed deposits. Between 1981 and 2017, gold offered nominal return of 9.4% CAGR – purely in the form of capital appreciation.

Sovereign Gold bonds or gold-deposits earn you money in addition. Rather than paying banks for maintaining your lockers, you receive regular interest payments by participating in these schemes. Besides, you do not miss out on capital appreciation.

In addition, these scheme offer tax incentives, which acts an icing on the cake.

Add 2.5% interest to 9.4% capital appreciation and you get a very healthy return of 11.9% per year tax free.

So, if you are considering to add gold as an asset class within your investment portfolio, or already a gold investor using physical or ETF routes, go for these schemes as they offer attractive alternatives to traditional investing. In addition, it helps the nation by putting your idle asset to productive use and reduces the trade imbalance.

P.S. Did you know?

1. The Padmanabhaswamy Temple is the richest place of worship in the world

In 2011, a team of investigators discovered a treasure trove of gold jewellery, objects and 100,000 historic gold coins in the underground vaults of Kerala’s 16th-century Padmanabhaswamy Temple. Its total wealth is estimated to be around $15 billion and more riches are believed to be hidden in the vaults.

Image: Aijaz Rahi/Associated Press

2. The Tirupati Temple isn’t too far behind

The Tirupati Temple has around 4.5 tonnes of gold deposited in banks, which gets an interest of around 80 kg of the yellow metal every year. The gold comes from offerings and donating by devotees in the form of biscuits and ornaments. The temple was considered to be the richest in India, until it was toppled by the Padmanabhaswamy Temple.