Sovereign Gold Bond Scheme-2020-21, a well-timed move by the government  

Background

As we all aware, RBI has issued sovereign gold bond scheme 2020-21 in accordance with the guidelines issued by the Ministry of Finance vide it’s notification dated April 13, 2020.  The Sovereign gold bond scheme 2020-21 is launched in VI tranches starting from April, 2020 to September, 2020. Let’s try to understand the scheme and whether it is really beneficial for the retail investors or the government will be the real beneficiary under this scheme. 

Features of the Scheme

1. Who can apply under the Scheme?

The Bonds will be restricted for sale to resident Indian entities namely individuals, HUFs, Trusts, charitable institutions, and Universities.

2. Minimum and Maximum amount can be applied?

As per the notification, an Individual or HUF can apply for bonds equivalent from 1gm of gold to maximum 4Kg of gold while trusts and other similar entities may apply bonds upto 20 KG equivalent gold.

3. What is the maturity period and is it possible to redeem the same before maturity? 

As per the notification maturity period of gold bonds is 8 Years and it can be Premature redeemed after 5 years. The redemption price will be calculated in INR based on the previous 3 working days simple average of the closing price of gold of 999 purity published by IBJA.

4. Is it possible to avail loan against the Sovereign Government bond funds? 

Yes, as per the scheme read with RBI rules granting loans and advances as amended by the MPC of RBI on 6th August, 2020, any individual may avail the loan upto the extent of 90% of the market value of the bond till 31.3.2021.

5. What is the interest rate and how capital appreciation will be determined?

Gold Bond scheme carries the 2.5% interest rate on the face value of the bond and as the name suggests sovereign gold bonds derive the value by it’s underlying asset i.e Gold, Face value and the redemption value of the bond is derived based on previous 3 working days simple average of the closing price of gold of 999 purity published by IBJA simultaneously. So, the Investor will get the reward/loss as per the gold rate at the time of redemption/sale of the bonds.

6. What is the taxation of Sovereign Gold Bond Scheme?

Sovereign gold bonds are treated as capital assets as per section 2(14) of the Income Tax Act, 1961, hence, short term or long term capital gain will arise on the sale/transfer of the bonds. However, the government has given an incentive to the individual investors by the route of section 47 of the Income Tax Act, 1961 wherein redemption of sovereign gold bonds on the maturity of the bonds have not been regarded as transfer resulting in no tax. Interest received on sovereign gold bonds will be taxable under the head other sources.

In the light of the above paras we have understood that an investor will earn a nominal interest of 2.5% on the bond amount and will reap the benefits of price appreciation of gold as capital appreciation in the long period of time.  

Is the return of Gold are extraordinary –Let’s see:

Every one of us must have heard from our parents, relatives, uncles, aunts, or any aged friends/clients “Hamari shadi k Time Gold —- tha ab dekho kaha chala gaya”. Everyone who has been watching gold since 1st January, 2020, is feeling “Kaash Gold Kharida Hota” and why not, it has given absolute return of 39% in just a small period of 7 months. Thinking on the same line, I started analyzing the gold return for the past four decades and have tried to understand whether the gold has given incredible returns in the past or is it the simple effect of Compounding- The 8th Wonder of the World.

Few Historic Returns of the Gold

Year Average Price of Gold in INR Average Price of Gold in INR 2019 Approximate CAGR Return
1981 1800 35220 7.92%
2010 18500 35220 6.70%
2015 26343 35220 6.40%

Decade wise return analysis of Gold since 1981

Year Average Price of Gold in INR at the beginning of the decade Year Average Price of Gold in INR at the end of the decade Approximate CAGR Return
1981 1800 1990 3200 6%
1991 3466 2000 4400 2.5%
2001 4300 2010 18500 15.70%
2011 26400 2019 35220 3.3%

 (Source: Average Gold Prices are taken from bankbazaar.com)

These two tables depict Gold had given very poor return in three decades out of the four decades, even there is a good chance that term deposits with banks must have outperformed the gold by a huge margin.

The astonishing return delivered by the gold was the period of 2001 to 2010, the period of two major economic crises wherein markets/economies crashed like never before.

2002 the Dot Com Crisis: The dot com bubble burst in October, 2002 and technology stocks fell down upto 95% resulting evaporation of wealth of the investors and money started moving towards the safe haven i.e gold, surging gold prices.

2008 The Financial Crisis: In 2008-2009 world witnessed a crisis never seen before, top banks of the world started to fall due to the collapse of Lehman Brothers and other financial institutions, resulting money started to find safe haven for itself which surged gold prices.

The effect of these crises was gold generated astonishing wealth for it’s holders but can a non- productive asset give such astonishing returns, the same is being answered in the next years wherein gold gave no returns or negative returns was delivered by the Gold till the beginning of the new unique crisis (Covid-19 Pandemic).

The legendary investor Warren Buffet explains gold investment in it’s letter to shareholders of 2011 in an exemplary way with the help of an example, extract of the example produced here:

“Today the world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce – gold’s price as I write this – its value would be $9.6 trillion. Call this cube pile A.

Let’s now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?

A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops – and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.

Admittedly, when people a century from now are fearful, it’s likely many will still rush to gold. I’m confident, however, that the $9.6 trillion current valuation of pile A will compound over the century at a rate far inferior to that achieved by pile B.”

How government is making money through sale of sovereign gold bonds scheme

The government of India had notified sovereign gold bond scheme 2020 at a time when the world is going through the Black Swan Event (Covid -19 pandemic) resulting, surging of gold prices and money again chasing the safe haven. The government is not selling it’s gold reserves, as the same will reduce it’s capacity to infuse money in the system, rather it has chosen a smart way issuing a piece of paper stating liability of the government to pay in future based on future gold prices carrying the interest rate of mere 2.5% per annum (Less than the interest rate earned by us on saving account). By the now, we have understood there is a good chance Gold prices surge when world faces any Black Swan Event and it fades it’s shine when the economies around the world perform well.

Trusting that the world will overcome from this pandemic and humanity is not going to end, the world economies will start to recover by the end of 2021, productive assets will once again be the doll of the market and bull run will continue to remain for 5-10 years. Analyzing the above one may intellectually conclude that gold prices are not going to surge so much and it may decline as well in the upcoming 5-8 years and here comes the time of repayment of dues by the Government of India.

Concluding Remarks: Gold Sovereign Bond Scheme is much productive asset class than holding the physical gold, as it carries an interest rate of 2.5% per annum while physical gold doesn’t generate any return except the capital appreciation arising out of the fear of the people. Average gold prices which have surged from Rs 1,800 in 1981 to Rs. 35,220 in 2019 is the effect of the compounding, which teaches the lesson Compounding is the real 8th Wonder of the World. Gold may continue to shine until world economies witness the turnaround.

 *****

Disclaimer: The Content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice. All Content in the article is the information of a general nature and does not address the circumstances of any particular individual or entity. Please discuss this with your financial advisor before making any investment decisions.

CA Kanj Goel – Kanj3101@gmail.com

Author Bio

Name: KANJ GOEL
Qualification: CA in Job / Business
Company: Tradex India Corporation Private Limited
Location: NEW DELHI, New Delhi, IN
Member Since: 04 Aug 2020 | Total Posts: 7
Chartered Accountant having 10 years+ experience in Taxation Advisory, Financial Advisory, Financial restructuring, Funds Management, Consolidation of accounts, MIS. Stock Market Investor, Learner, Reader. View Full Profile

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2 Comments

  1. Lalit Kothari says:

    Author is mischievously comparing with average price of gold prevailed in 2019 at Rs.35,220/- which is not at all desirable when you compare in 2020. If you take average price of gold of first 6 month of 2020, which is drastically high as compared to 2019, you will arrive at the conclusion that the by investing in gold, one has taken a smart decision.

    1. Kanj_goel says:

      Mr. Kothari,
      Thanks, for digging out time, out of your busy schedule, to share your valuable thoughts on my article. Perusal of comment led me to the conclusion that either you couldn’t go through the entire article in toto (due to shortage of time) or I, failed to explain the intent of the article to you. I, once again, put endeavors to explain the intent of the article.
      In the article, we have tried to understand the following:
      1. Government has launched the scheme at a very appropriate time to raise funds at a very low rate of interest during the period of surging gold prices which may fall or remain stagnant at the time of maturity of the scheme, leading to no return or very low return to the investors at the maturity of the scheme.
      2. Gold shines when global economies fade due to the black swan event causing fear among the people.
      3. Out of the four decades in most of the period return of gold is very ordinary or less than ordinary but compounding of four decades have played it’s role which teaches the lesson give time to your investment.

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