Gold Monetization Scheme

The Union Cabinet recently approved gold monetization scheme and Sovereign Gold Bonds. The Main objective behind the launch of gold monetization scheme and Sovereign Gold Bonds is to reuse the household gold which lying in lockers & cupboards of Indian homes. and also reduce reliance on import of gold.
This gold monetization scheme and Sovereign Gold Bonds scheme will help in reducing the demand for physical gold. As we know most of the demand for gold in country is met through imports, this scheme will help in maintaining India’s Current Account Deficit in limits.
Let’s take a look at key features of Gold Monetization scheme and Sovereign Gold Bonds.
Gold Monetization Scheme (GMS):

1    1. Gold Monetization Scheme (GMS) allows jewelers and investors to deposit physical gold in banks. This scheme allows Rich Temples of India to deposit the gold in the bank. Eg.Padmanabhamswamy temple Kerala, Tirupati Balaji temple, Saibaba temple shirdi etc.
2. This scheme is nothing but the fixed deposit scheme for gold. Like you keep your gold in the bank and earn interest on it.
3. Gold bonds will be issued with a rate of interest to be decided by the government. Interest will be calculated on the value of gold deposited at the time of investment.
4. Investor has to deposit minimum 30 grams of gold in-order to earn interest on deposit.
5.  The bank/ govt will melt the deposited gold and it kept as a bullion.
6. If you give return preference as a gold interest will be given as a gold. For example, if you deposit 100 gms of gold and get 1% interest, on maturity will receive 101 gms.
7. The minimum deposition period for the Gold monetization scheme is 1 year and maximum 5 years.
8. just like fixed deposit you can break the gold deposits also.
9. No information of income tax exemption of such gold deposit yet. stay tuned. once I come to know i will post it here.
10. Gold collected through the scheme will be made available to jewelers for manufacturing of new jewelers and other items.

How Gold Monetization Scheme (GMS) works? Gold Deposits:

In this GMS customer can bring the gold in any form either ornaments, rings, bullions, gold bars etc. The gold deposit account will be opened by banks. The collection center will verify purity and assess the value of gold. This center will inform bank about value to be credited in the customer account. Then bank will melt the gold and will convert it in to bars. The customer will be pad interest amount OR gold as per the scheme on maturity.

Gold Savings Account:

When the customer produces the certificate of gold deposited at the Purity Testing      Centre, the bank will in turn open a ‘Gold Savings Account’ for the customer and credit the ‘quantity’ of gold into the customer’s account. Simultaneously, the Purity Verification Centre will also inform the bank about the deposit made.

Interest Payment by Banks:

The bank will commit to paying an interest to the customer which will be payable after 30/60 days of opening of the Gold Savings Account. The amount of interest rate to be given is proposed to be left to the banks to decide. Both principal and interest to be paid to the depositors of gold, will be ‘valued’ in gold. For example, if a customer deposits 100 gms of gold and gets 1 per cent interest, then, on maturity he has a credit of 101 gms.

Redemption:

The customer will have the option of redemption either in cash or in gold, which will have to be exercised in the beginning itself (that is, at the time of making the deposit).
Tenure:
The tenure of the deposit will be minimum 1 year and with a roll out in multiples of one year. Like a fixed deposit, breaking of locking period will be allowed.

Tax Exemption:

In the Gold Deposit Scheme (1999), the customers received exemption from Capital Gains Tax, Wealth tax and Income Tax. Similar tax exemptions are likely to be made available to the customers in the GMS after due examination.
Lending the Gold to the Jewelers: Gold Loan Account: 
The jewelers, on the basis of the terms and conditions of the banks, will get a Gold Loan Account opened at the
bank.

Delivery of gold to jewelers: 

When a gold loan is sanctioned, the jewelers will receive physical delivery of gold from the refiners. The banks will in turn make the requisite entry in the jewelers’ Gold Loan Account.
The banks can directly get gold from the international market on a consignment basis and lend it to the jewelers. If this route is more lucrative, then the entire purpose will get defeated. Thus, this aspect will also have to be kept in mind, while deciding the interest rate.

Sovereign Gold Bonds

1.The sovereign gold bond will enable investors to buy gold certificates from the government, which can later be encased for money or physical gold.
2. Gold bonds will be issued with a rate of interest to be decided by the government. Interest will be calculated on the value of gold deposited at the time of investment.
3. Gold bonds will be issued in denominations of 5, 10, 50, 100 grams of gold. The cap per person per year has been set at 500 grams, the government said.
4. Duration of such gold bonds will be for minimum of 5 to 7 years to protect investors from medium term volatility in gold prices, the government said.
5. Gold bonds are expected to reduce the demand for physical gold bars and coins by shifting a part of estimated 300 tons per annum for investment into gold bonds.
6. The risk of change in a price of gold will be borne by the government.
7. One can use this bond for applying for loan as a security.
8. Banks/NBFCs/Post Offices/ National Saving Certificate (NSC) agents and others, as specified, may collect money / redeem bonds on behalf of the government (for a fee, the amount would be as decided).
9. Bonds to be easily sold and traded on exchanges to allow early exits for investors who may so desire.
10. Upside gains and downside risks will be with the investor and the investors will need to be aware of the volatility in gold prices.
This scheme will surely help many Indians and Indian economy. The government have very high hopes from this scheme. If all temples from India started depositing their gold reserved with banks, then it will be huge success.

According to the latest news First tranche of Sovereign Gold Bonds 2015-16 receives good response.  Total subscription denominated in units of gold was 9,15,953 grams amounting to Rs 246 crore as the RBI reported.

Some of Question from Public on Gold Monetization scheme and Sovereign Bond scheme

Question 1: Why should I invest my gold in gold monetization scheme when I've the option of selling the gold and depositing the cash at a higher rate of interest?

Answer: Investing in Gold Monetizing scheme is similar to investing in shares of a Blue chip company. You get 2-4% tax free interest (dividend) plus market value of that share appreciates.
If the value of gold (shares) increases over time, your invested amount increases besides regular interest (dividend) of 2.5% on your investment.
Gold has appreciated about 10x in last 20 years.
Coming back to question, if you sell gold and invest that money, you will get fixed interest of 7-8% which is taxable. 

Question 2: How will Sovereign Bond scheme impact Indian economy?

Answer:  1. By reducing gold imports, it will help our Forex consolidate more and more with time.
So, in long run, it will impact India by improving our balance sheets as gold is second largest import by us after fuel and reducing its bill we can divert the saved money for our public projects and investment and pace up our growth by a significant point.

2. As people will get bonds as an investment substitute option of physical gold directly which is risky to keep at home, they will find investing in bonds attractive which will help raise money for government via domestic routes as domestic debts and savings are always preferred because external debt can turn out to be very expensive for the country.


But there are some problems also still to be dealt with or look for related to the scheme:

1. Although the scheme provides for a good 2.75% interest on the bonds, but the interest earning will have Capital gains tax(CGT) applied on it, which can discourage investors a bit.

2. More important thing: major part of gold is concentrated in hands of top 3% of rich population of the country including the black money which is about 60% of GDP, they store it in different types of assets like gold bullion, property etc.
So getting gold out from them will be a major hurdle, as they will not be willing to disclose it which has it in large amounts and constitute the major part of investment driven demand of gold, so the scheme will have to be properly synchronized with appropriate policies of black money tackling, so that more of gold which we want can be received to be utilized.

 Will Sovereign Gold Bond scheme not create sharp decrease in Gold price in Indian market, as supply is drastically increased?

 

Before we dive into the topic, let’s have some insights about Gold as an Investment.

Price of Gold in December 2005 was ≈ 500$. Price of Gold in November 2015 is ≈ 1134$. That is a Compound Annual Growth Rate (CAGR) of 8.5%.
We have heard great stories from our parents and grandparents about the amazing returns they earned on Gold in last 25 years. Let’s give that story a reality checks too!

Price of Gold in January 1990 was ≈ 399$. Price of Gold in November 2015 is ≈ 1134$. That is a CAGR of merely 4.3%.
Putting money in Fixed Deposits would have given them better returns.
Well, on the face of it, Gold IS NOT a great investment avenue, maybe  its time you explain to your parents how they lost money by buying and  holding Gold.

Putting Money in Gold, in fact, ate up almost 87% of the money originally invested. How?
Inflation.  This monster ate away their wealth. From 1990 up until now average inflation rate in India has been around 8%. Which means, Value of INR  1,00,000/- in January 1990 is diminished to INR 12,436/- . i.e. the Value diminished by a whopping 87% since 1990.

The Charts and Data clearly demonstrate that in the past 10 Years Gold has barely managed to beat inflation.
In the last 25 Years, Gold has in fact given negative returns. [(-8%) inflation + 4.3% returns on gold] that amounts to a (-4%) Return in the last 25 Years.

So much! For being called a Precious Metal.

What are the Primary reasons that we Indians buy Gold?

1.       Gold purchased by Current Generation is rarely sold. Rather Gold flows down in our Country from Generation to Generation. You may have heard the stories of how your mother is wearing the necklace gifted by her mother, who in turn received the gift from grandmother; so on and so forth.  Each Generation adds a little more gold to the wealth and passes off to the next generation. This accumulated Gold is highly liquid, meaning in times of crisis the Gold is mortgaged to raise Capital and in extreme but rare case, Gold is completely sold out to prevent further disaster.  This is how we Indians use Gold to Hedge against bad times.

2.      Gold is used to hoard Black Money. It can be purchased for and sold off for unaccounted cash.

3.      Gold is considered an auspicious metal and is used to decorate temples and deities.

Thus, Gold is rarely used as an investment in our Country. It is rather used as Hedging Instrument and has Emotional Value for us.

How do we accumulate Gold?

1.       Jewelry is the most common form in which we accumulate gold. We wear, we gift, we rent and more with Jewelry, but we rarely sell it.

2.      Gold Coins & Bars, these are purchased from Banks or Jewelers during auspicious occasions. They are mostly gifted to someone or the other, but rarely sold.

3.      Gold Funds and Gold ETF’s: These are Mutual Fund Schemes which generate returns that corresponds to the returns provided by price of gold through, direct or indirect investment in physical Gold. Gold Funds and Gold ETF’s are relatively new investment vehicles that have been introduced in the Indian Markets. None of these funds have been able to generate more than 4% CAGR in the past 5 years.

4.      Sovereign Gold Bonds Scheme: since this is our Core Topic, we shall discuss the same in detail in next point.

What are the salient features of the Sovereign Gold Bonds Scheme 2015?

1.       SGBs are government securities denominated in grams of gold. They are substitutes for holding physical gold. Investors have to pay the issue price in cash and the bonds will be redeemed in cash on maturity. The Bond is issued by Reserve Bank on behalf of Government of India. The bonds are held in the books of the RBI or in demit form eliminating risk of loss of scrip.

2.      To curb the import of Gold, the Government wants You to purchase Gold Bonds rather than Physical Gold. As per the Government, SGB offers a superior alternative to holding gold in physical form. The risks and costs of storage are eliminated. Investors are assured of the market value of gold at the time of maturity and periodical interest. SGB is free from issues like making charges and purity in the case of gold in jewelry form.

3.      The Bonds will be issued in denominations of one gram of gold and in multiples thereof.  Minimum investment in the Bond shall be two grams with a maximum buying limit of 500 grams per person per fiscal year (April – March).

4.      The customers will be issued Certificate of Holding on the date of issuance of the SGB. Certificate of Holding can be collected from the issuing banks/Post Offices/agents or obtained directly from RBI on email.

5.      The tenure of the Gold Bonds is 8 years, and redemption is allowed only after the 5th year.

6.      The Sole Attraction of the scheme is that the Bonds bear interest at the rate of 2.75 per cent (fixed rate) per annum on the amount of initial investment. Interest will be credited semiannually to the bank account of the investor and the last interest will be payable on maturity along with the principal.

7.      Interest on the Bonds will be taxable as per the provisions of the Income-tax Act. Capital gains tax treatment will be the same as that for physical gold.

8.      On maturity, the redemption proceeds will be equivalent to the prevailing market value of grams of gold originally invested in Indian Rupees. The redemption price will be based on simple average of previous week’s (Monday-Friday) price of closing gold price for 999 purities, published by the ‘India Bullion and Jewelers Association Ltd’ (IBJA).

9.      These Bonds are eligible to be used as collateral for loans from banks, financial Institutions and Non-Banking Financial Companies (NBFC).

The RBI Circular in regards of the SGBs is available for downloading athttps://www.sbi.co.in/portal/doc....


Our Opinion.

·         We have already established that Gold in itself is not an intelligent investment vehicle. Over the long run it has given negative returns.

·         As previously observed, we do not sell gold so easily. Not unless, there is no other way to survive. Gold is accumulated over centuries and passed on to coming generations. The SGBs has a tiny tenure of 8 years.  That beats our primary objective for holding Gold.

·         The  SBGs is also extremely illiquid, as opposed to Physical Gold. Although  both forms of Gold can be used as Collateral for obtaining Loans. This  kills our next most important objective of holding physical Gold: to  liquidate in times of extreme distress.

·         Interest on SGB is taxable. The gains, if any, which You earn after redemption, are also subject to Capital Gains Tax.

·         You will not be receiving Gold on redemption! You will receive only cash.  Also 8 years is too small a period to guarantee that Gold prices will rise sharply. As you can see in “Image No. 2”, there was negligible price movement since 1990 till 2005. It was only from 2006 that prices started rising. But since 2014 the trend seems to have reversed.

·         Fixed Deposits in India offer ≈ 8% Compound Interest (Pre Tax). 1,00,000/- Rs. invested at 8% for 8 Years shall fetch You ≈ 1,85,000/- Rs. Let’s compare this to Gold. 24Karat Gold in Mumbai costs Rs.2,557/- per gram, and to beat the Fixed Deposit Returns, Gold will have to rise by ≈ 85% in next 8 years to turn into ≈Rs 4,732/- Which we think is highly  improbable. So You are better off investing Your hard earned Money in Fixed Deposits.

·         There is a bigger concern with the SGBs. The scheme is cannibalistic, meaning that if this SGB is successfully implemented, it will cause Gold prices to fall, not rise.  How?

·         India is the second largest Gold Importer. India imports about 800 to 1,000 tons of gold annually. Total gold imports in 2014 was $31.2 billion. ICRA expects a 5% drop in Gold Imports in coming months due to the various Gold Schemes launched by Indian Government. If this Scheme along with the Gold Monetization Scheme is successfully implemented, the Demand for Gold will drop drastically. On the other hand, the Gold Reserves with the Government will rise. Thus there will be Over Supply and Under Demand at international level; which will in turn halt any upward price movement. Thus giving negative returns in the long run.

·         Notice carefully and you will discover something interesting. The World Gold Council is busy promoting the idea that Gold is a good investment. Fund Houses and Stock Exchanges are busy promoting Gold Funds and Gold ETF’s. The RBI is busy promoting the Gold Bond Scheme. Your Investment Advisor will be persuading You to buy Gold Funds/ETF’s or Gold Bonds; if he also owns a Jewelry Store he will persuade You that physical Gold is a good investment too!

This is what Warren Buffet has to tell us about Gold:

        “Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig          another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head”