Enter gold bonds only if you have at least a 5-year investment horizon

Gold Bonds
Four tranches of sovereign gold bonds (SGBs) will be issued between June and September this year. With the global economy moving into a slower growth trajectory, and the trade wars between the US and its partners showing no signs of abating, financial advisors are asking their clients to take exposure to gold, the traditional safe haven. 

Last week, the price of gold spurted internationally due to growing tensions between the US and its partners. The trade-related tensions with China continue to boil, with neither party prepared to back down and both ready to impose retaliatory tariffs. “A new dimension has crept in with the US threatening to use tariffs as a weapon in its ongoing immigration-related tussle with Mexico,” says Chirag Mehta, senior fund manager-alternative investments, Quantum Mutual Fund.

The looming global economic slowdown also works in favour of the yellow metal. The US Federal Reserve is now expected to cut interest rates. Low real interest rates are favourable for gold. Other economies besides the US too are facing trouble. “Yields on many sovereign bonds are zero or negative at present. Europe is facing a slowdown. The Brexit issue could prove disruptive. This stressful environment could affect all fiat currencies, which is why one needs gold as a portfolio diversifier,” says Somasundaram PR, managing director, India, World Gold Council.     

Since the onset of trade wars, China has been looking to diversify its reserves. “China, earlier the largest purchaser of US gilts, is now building its gold reserves instead,” says Prateek Pant, head of products and solutions, Sanctum Wealth Management. 
One factor currently keeping the yellow metal range bound is the strength of the US dollar. “It remains strong not due to the strength of the US economy, but due to weaknesses elsewhere. The eurozone, Japan, etc are all facing their own economic issues,” says Mehta. Moreover, it occasionally appears that the trade wars will get resolved. “If there is a positive outcome to trade-related issues at the G20 summit, the rally could fizzle out,” says Ramesh Varakhedkar, vice president, commodities and currencies, Karvy Stock Broking.  

Nonetheless, investors who do not have at least a 10-15 per cent allocation to gold in their portfolios should start building it now. Varakhedkar suggests buying gold on dips. 

The biggest advantage of SGBs is that they pay an annual coupon of 2.5 per cent. In other instruments, your returns are determined purely by the change in gold’s price. “If these bonds are held until maturity, the capital gains are exempt from taxation,” says Somasundaram. 

However, SGBs are not very liquid. Their total tenure is eight years but investors can exit after five (on the date of payment of interest). “Though they are listed on the stock exchanges, trading volumes tend to be low,” says Varakhedkar. Only investors with at least a five-year investment horizon should enter them. 

Besides buying in primary issues, another option is to buy older tranches in the secondary market at discounts ranging from 3.79-9.17 per cent over the current price (see table). “Some of the earlier tranches carry the higher coupon of 2.75 per cent. The yield can go as high as 2.86 per cent. Your maturity period is also lower if you buy from the secondary market,” says Pant.

When choosing from the older tranches, match the residual maturity of the paper with your investment horizon and factor in the yield to maturity. Since daily trading volumes are low, only smaller, retail investors can exercise this option.