What is Sovereign Gold Bond?
Sovereign Gold Bond or SGB is a bond issued by RBI. It has a maturity duration of 8 years and pays 2.5% per annum interest paid half yearly. There is an early redemption option provided at the end of 5th, 6th and 7th years. It can be traded on the stock exchanges without any restriction from the date of allotment. It was first issued in Nov 2015. There are several issues every year. The current year’s issues can be found under this link. There is an issue which has opened today (11th May 2020) and will close on 15th May 2020. The price per gram is Rs. 4,590. There is a discount of Rs. 50 for digital applications. The official RBI press release is here
Who Can invest in it?
Any person resident in India, HUF, a Trust or a Charitable institution can invest in it. NRIs are not permitted to invest in SGB.
How does it work?
The price of the bonds is fixed on the basis of average of closing price of gold of 999 purity published by the India Bullion and Jewelers Association Limited for the last three business days of the week preceding the subscription period. The redemption price per gram will be calculated on the same basis. So SGB is a means to participate in the price of gold without actually buying gold. And there is an interest given as well. In other words, it is a futures contract where the issuer promises to repay the worth of gold at the market value of gold at redemption. What happens if the price per gram at redemption is lower than the purchase price? Well, that is precisely the risk in buying the SGB. What if the price of gram is much higher than the purchase price? This is where the sovereign guarantee comes into the picture. RBI manages India’s Forex reserves and a part of it is in Gold. As on end of march 2020, Gold reserves is 653 tonnes. The source of this data is RBI reports which can be found here. The SGB issued is only a fraction of the Gold reserves.
How is Gold ETF different from SGB?
Today, there is different ways to invest in gold without physically buying it. The Gold BeES ETF was launched by Benchmark mutual fund in 2007. Today this is traded in the stock exchanges under the name Nippon Gold BeES ETF. There are several other Gold ETF and Gold funds which are available for purchase for investors. The basic principle behind their working is that during NFO, the money collected is utilized to purchase gold bars and stored in safe vaults. There is an Expense ratio which takes care of the operational costs of safekeeping and fund management. So essentially, an investor is today able to purchase these ETFs or funds and participate in the price movement of gold.
Why is there a sudden interest in Gold?
Gold has historically been a store of value. Whenever there is a crash in stock market, gold price has move up in the past. Gold price has been moving up dramatically in the past 1 year. This can be seen from the issue price of past SGBs. This data is sourced from RBI’s website under this link.
Gold prices have been very volatile in the past. You can see the fluctuation in the the gold price from the below chart. The data is sourced from gold.org which has data from 1979.
The gold price per gram in rupees (red line) has been less volatile compared to the USD per ounce (blue line). While the USD price per ounce is yet below the 2011 peak, the INR per gram has already reached an all time high. Will it continue the momentum or fall behind once the corona virus issues are resolved is anyone’s guess.
8 year rolling returns of gold
Let us check what has been the returns on gold in the past for every 8 year period. How are rolling returns calculated? For a purchase date of 02.01.1979, the sale date is 8 years later, 02.01.1987. Similar to this, the data used has 8,697 purchase dates and sale dates. The gold price data is sourced from gold.org.
As seen in the graph above, there are a few 8 year periods where the returns have been negative. The average return is 9.84% with a standard deviation of 5.5%. The maximum return is 23% and minimum return is -0.74%
Warren Buffet considers gold as an unproductive asset, why should I invest in SGB
Warren Buffet has been very vocal in his dislike for gold as an investment. Gold according to him is an unproductive asset. You buy it at a price and expect someone to come along and pay a higher price for it. Well, his opinion maybe correct for physical gold. SGB is not physical gold. It is a bond issued by RBI on behalf of government of India. The money collected will be used by the government for all its normal activities. So in essence it is put to productive use for India’s growth and development.
Who should buy SGB?
SGB is ideal for you if you would anyways buy gold after 8 years. You can redeem SGB and buy physical gold. By not buying gold now, you are saving on the safekeeping cost and you are paid an interest of 2.5% per annum. If you are an investor investing in equity for long term goals, you can include gold in your portfolio to reduce risk. An exposure of between 10% to 20% is recommended for goals which are over 10 years away. There is also a need to re balance the portfolio maybe once a year. For re balancing, you may have to sell SGB in the market or buy it in the market. The SGB has only retail investors and has limited liquidity. It used to be traded at a discount of upto 10% in the past. However, currently is seems to be traded closer to the spot price of gold. Below is the screenshot from NSEindia under this link.
SGB is a very good product with sovereign guarantee. It can be used prudently by Indian public to participate in the price movement of gold without buying physical gold. It is an ideal investment for you if you would anyways buy physical gold in the future. As an investor, you can use it to reduce investment risk by including it in your portfolio.