The Reserve Bank of India (RBI) has announced the auction of sovereign gold bonds on its Retail Direct Portal website. Few of the features (details on the RBI page)
Coupon Type – Fixed
Coupon Rate – 2.5% per annum (paid semi-annually)
Payment options – UPI, Netbanking
Bidding Start Date – 19 June 2023
Bidding End Date – 23 June 2023
Allotment Date – 27 June 2023
Maturity Date – 27 June 2031
Issuing price : Rs 5,876.00 (discount of Rs 50 per gram for online customers)
Early redemption – after 5th year (bond will be tradable on Exchanges)
Tax angle – exempt from Capital Gains Tax, coupon income is taxable
Primary Risk – Capital loss if market price of gold declines at time of maturity / redemption
The question is on the appropriateness of this financial product for your portfolio. Not all products are suitable for all investors.
Primer on the product
SGBs are a derived product – the underlying asset being gold. The purchase unit is 1 gram and an investor can buy multiple units with an upper limit of 4 kg. The price at issue and at redemption is based on the simple average of previous three days of closing price of gold (999 purity) published by the Indian Bullion and Jewelers Association Limited.
Since it is a bond, you get coupon (interest income) at 2.5% per annum that is paid semi-annually. At the time of maturity (after 8 years), you get the market price for the number of units you hold. And this is where things get tricky.
SGB as an investment option
Gold as an asset class is largely influenced by the state of the economy – the world economy. The graph below may not throw up the volatility and the close connection of the price of gold to the economy but is worth looking at if you are convinced this is the right product for you.
Take a look at the chart below from the World Gold Council
However, unlike most products, the price of gold has been known to fluctuate – driven by political factors, price of oil, and on one occasion – even the pandemic which caused the world economy to come to a standstill. The chart below from macrotrends.net (link at the bottom of the page) shows the history. Inserted in boxes, I have captured the primary reasons attributable for the upward trend. Standing today, it is almost impossible to know the direction of the price 5 years later when the option for early redemption starts. Since, in essence, you are taking a call on world economy at the time of redemption of the bond.
Recommendation
For a retail investor looking to build a corpus or an investor looking to deploy funds for earning interest income during retirement, this may not be the best product to look at. The reason being the risk mentioned above – the price of gold at maturity. Remember, the fixed coupon from the bond is 2.5%. Those buying this product will primarily be looking to earn from the price of gold at maturity. If the price at that time is higher than the price at the time of purchase, the investor makes money.
If you are looking to diversify your investments and add on gold as an asset class, then this is the right product for you. More suitable than physical gold which has storage, security and convenience issues. In addition to the capital gains which is tax exempt, you also get a (taxable) coupon income of 2.5% annually.
In terms of target profile, this product is suitable for HNIs and UHNIs given the benefits from diversification, liquidity and tax exemption.
Sources:
https://www.macrotrends.net/1333/historical-gold-prices-100-year-chart'>Gold Prices - 100 Year Historical Chart https://www.reuters.com/article/us-gold-milestones-idUSTRE73K10020110422 https://money.cnn.com/2011/08/22/markets/gold_prices/index.htm https://www.theguardian.com/business/2020/aug/05/after-covid-19-just-how-high-will-prices-go-in-the-2020-gold-rush
Well said