Sovereign Gold Bonds Usually Trade Below Issue Price On Exchanges; Should You Worry?

Most Sovereign Gold Bond issues are trading below the spot gold price. Here’s why that happens and why you shouldn’t panic and book your losses and stay for the long term
Sovereign Gold Bonds
Sovereign Gold Bonds

Sovereign Gold Bonds (SGBs) promise to give the best returns of all gold investment options as they pay the value of the metal as well as an additional interest rate at the time of maturity, but that’s true only if you are a long-term investor.

An SGB investor recently wrote to Outlook Money, saying he subscribed to the January 2022 Series IX (SGBJAN30IX) of the SGB issue and was surprised when his account statement showed negative returns in March, while the value of gold had risen over the period.

He had invested in 1 unit (1 gram) of SGBJAN30IX at Rs 4,736 via online mode on January 19. The price of gold futures on MCX was Rs 4,794.9 per gram. On March 23, when he checked his account statement, the value displayed was Rs 4,681 per gramme on a day when gold prices were Rs 5,137.9 per gramme on MCX.

I may have been better off buying gold from my local store, as I know the owner. I wouldn’t have made losses, "he wrote.

The investor’s fears, however, may be unfounded if he is not looking at withdrawing before the five-year exit window. That’s because the trading price does not reflect how the maturity value of SGBs is calculated.

All SGBs carry an interest rate of 2.5 per cent, payable semi-annually, and have a tenure of eight years with an option to redeem from the fifth year onwards. These bonds are offered at a Rs 50 discount to the price at the time of issue. The price of new issues is determined as the simple average of the closing price of gold of 999 purity published by the India Bullion and Jewellers Association Limited (IBJA) for the preceding week.

The Distinction Occurs In The Secondary Market

SGBs can be bought in two ways: via primary issuance by RBI and in the secondary market on recognised stock exchanges such as the NSE and BSE.

However, SGBs trade at a discount to the gold spot price in local markets. For example, the price of gold futures on MCX was around Rs 5,182 for 1 gramme at 11 am on March 25, but the price of SGBJAN30IX was Rs 4,699, a difference of approximately Rs 483.

The primary reason for this difference is that trading volumes in the debt market are extremely low. For example, the trading volume of SGBJAN30IX at 11 a.m. on March 24 was just 17 bonds. Simply put, only 17 bonds worth Rs 80,000 changed hands at the counter.

"For SGBs traded in the secondary market, the prices are determined like any active public security, i.e., by the forces of supply and demand," says Sonam Srivastava, founder and CEO of Wright Research and fund manager at Smallcase, an investment platform. "The dynamics of demand and supply also play a role, plus there is not too much liquidity present for these instruments. These factors make the SGB bond prices differ from actual gold prices, "adds Srivastava.

"The lack of demand affects the prices. While they are tradable on exchanges (i.e., the secondary market), the low levels of liquidity because of their structure could potentially result in the bonds trading at discounts," says Ghazal Jain, fund manager, alternative investments, Quantum Mutual Fund.

So, if you were to sell in the secondary market, the price may be lower than expected.

"Since SGBs are also traded on the exchange, investors who wish to sell prematurely should keep a close eye on the trading volumes, the trading price, and the actual price of gold. Lack of liquidity can be a huge concern, and I advise investors to wait for the trading price of SGB to catch up with the actual gold price, or at least wait for the RBI's SGB buyback window, which happens from the fifth year onwards, so that they do not unnecessarily face a capital loss in redeeming SGBs due to the trading price and actual price mismatch, "says Rushabh Desai, founder of Rupee With Rushabh Investment Services."

SGBs are long-term instruments.

From the fifth year onwards, RBI has also given investors an option to redeem their SGBs at the prevailing price calculated by them. For example, the gold price on February 8 on MCX was Rs 4,830 per gram, and the RBI fixed the premature redemption for the SGB at Rs 4,813. The cost of production will be deducted from this figure.Moreover, you would have been paid the interest semi-annually for the last five years.

"While SGBs pay annual interest and are tax-efficient, they have low liquidity (due to an eight-year tenure with an exit option in the fifth year")," says Jain.

SGBs are long-term investment instrument 

SGBs are suitable for long-term investors who wish to take an investment position in gold and also earn a fixed interest rate. If you have invested in SGBs, then you should ideally hold them till maturity as the redemption proceeds are tax-free as per section 47 (viic) of the Income Tax Act, 1961.

Investors should ideally buy SGBs with a long-term investment horizon, especially those who can hold the product until maturity and wish to gain exposure to gold without physically buying one. Moreover, SGBs are backed by the sovereign. Thus, investors need not worry about its purity and inventory, and can invest without any stress, "says Desai.

If you can hold on to your SGBs till maturity, you will earn an assured interest rate and tax-free redemption proceeds. At this stage, the redemption price offered by RBI will be the same as the spot gold price, so you won’t have anything to worry about.

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