Sovereign Gold Bonds need not glitter always

The first Sovereign Gold Bond (SGB) issue was sold in 2015 for a face value of Rs.2,584, the price of a gram of gold on the date of issuance , and the same was redeemed after eight years in November 2023 when it attained maturity by the Reserve Bank of India (RBI), the issuer of the bond, at Rs.6,132. The gold-denominated government instrument gave a decent return of 13.55 per cent to investors. In break up, 10.8 per cent appreciation of gold price during the eight years and the assured interest of 2.75 per cent (Since been lowered to 2.5 per cent).

Both the subscription and redemption prices are the simple average of closing price for gold of 999 purity of the last three working days of week preceding the subscription perid./ day of maturity. .

Lured by the better-than-expected returns in the first edition, investors could be very enthusiastic about the second tranche of the SGB issue opening for subscriptions from February 12-16

Though it is a much safer investment since it is a sovereign (government) bond, it is unlikely that the investor could get the return at the level of the first issue. Of course, the government will pay the assured interest of 2.5 pe rcent. But the main attraction of the instrument is the appreciation of gold price. An ordinary investor blindly believes that the gold price moves up every year. But it is unlikely.

In India, the gold price is determined by two factors. The international price of the precious metal and exchange values of rupee against the US dollar. India’s annual demand for gold comes to around 1000 tonnes. Since the country has no domestic supply of the metal, it almost totally depends on imports to meet the demand. Hence the international price of gold is very important for India. Swings in these two components make gold highly volatile in the Indian market.

The geopolitical conditions and other global developments are very much influencing the price movements of gold. If there is any development like war or political uncertainty that makes other avenues like equity and debt markets not safe, investors would flock to gold, always a safer investment instrument, pushing up the price of the metal.

Similarly, volatility in oil is also a crucial factor in deciding the trajectory of the gold price. When there is a crisis in the oil market, investors in oil futures put their money in gold. This sudden demand for the yellow metal fuels its price spiral both in the spot and futures markets.

If the rupee weakens against the dollar, the gold price will go up in the domestic market and if the rupee gains ground against dollar, oil price may move down.

Since these factors are very tough to predict, the movements of gold prices are not foreseeable.

Gold price data for 20 years from 1990 to 2020 showed that over a 10-year holding period, it offered less than 10 per cent return about half the time, while it returned over 12 pe rcent about 40 percent of the time.

A look at the gold price movements during the bond period from 2015 to 2023 underscores the aforesaid trend in gold. Between 2015 and 2023, Indian gold investors faced two years of loss- an 8 per cent drop in 2020 and a 4 per cent fall in 2021 and two years of lower than-fixed deposits returns, 3 per cent in 2017 and 7 per cent in 2018. But bumper years like 2019 and 2020 added a 20 per cent gain in gold prices. Thus the returns from gold price fluctuations reached 10. 8 per cent for the investors of SGB.

Owing to this, unlike in equities, there couldn’t be much appreciation, if the investor holds SGBs for long.

This indicates that one cannot heavily depend on SGB for wealth creation.

Better than physical gold

However, the investment in SGB is better than betting the fund on physical gold, especially on jewellery . While disposing of/ buying jewellery or other physical bullion, investors' returns will reduce as the trader charges the investors (buyers/sellers) several things. But when comes to liquidity, physical gold is better. The investor is free to dispose of it when he/she wishes. But SGBs are sold and redeemed during limited windows of time decided by the Reserve Bank.

Unlike physical gold or gold Exchange Traded Funds (ETFs), the investor cannot cash out of SGBs at the time of his/her choice. SGBs once sold, are traded on exchanges. But they tend to feature low trading volumes making exit difficult. For an assured returns, the investor has to wait for five years, after which RBI offers to buy them back at a fixed price, or the investor needs to wait until the maturity date after 8 years. Gold ETFs, in contrast, can buy or sell at any time. But they don’t pay interest. They also entail an annual management fee which you don’t incur with SGBs.

For individuals, SGBs bought from RBI and held until maturity are exempted from capital gains tax. But all other forms of gold investments such as jewellery and gold ETFs are subject to short-term capital gains tax if held for less than 36 month and long-term capital gain tax if held longer