Should you invest in the fresh tranche of sovereign gold bonds?

Despite the COVID-19 lockdown being extended to May 3, the Government of India has decided to go ahead with the issue of sovereign gold bonds (SGBs). And unlike previous years, it seems to be in hurry to raise funds through gold bonds.

On April 13, the Reserve Bank of India (RBI) announced that it would issue SGBs to domestic investors in six tranches, starting April 20.

Rising gold prices are expected to elicit a strong response from investors. Here are five things that you must know about how SGBs work.

Rising gold prices

Over the past one year, gold prices have risen 27.3 per cent. The SGB tracks the price of one gram of gold. Investors are paid the value prevailing at the time of maturity.

But why have gold prices risen so much? The COVID-19 pandemic has led to massive economic slowdown worldwide. This has meant higher demand for gold as a perceived safe haven.

“In the backdrop of the COVID-19 pandemic, central bankers across the world have announced stimulus packages to revive their economies. These moves, along with the rising uncertainty have made investors take more exposure to gold,” says Rupak De, senior analyst, IIFL Securities. He expects the yellow metal’s prices to surpass the Rs 49,000 mark for 10 gram over the next 12 to 18 months, owing to strong gold prices in international markets and a weak rupee.

In the past, gold has come to the rescue of estranged portfolios when stocks turned volatile.

Sovereign guarantee

The SGB does not charge an expense ratio. Not does it carry costs associated with buying jewelry. There is sovereign guarantee as well. To be sure, the government has been issuing SGBs regularly since 2015. Up until now, these issues have coincided with festival times, as that’s when investors rush to buy gold.

In the current financial year, the government has been quick with the notification for the issuance of SGBs. Last financial year, the four tranches of SGBs were issued between June and September. However, this year, the government plans to issue six tranches of SGBs between April and September. “Probably the government expects that investors may move to gold as an investment option given the rising prices,” says Joydeep Sen, founder of wiseinvestor.in.

Investments in other classes aren’t doing too well these days. Falling interest rates have reduced the returns from fixed income instruments. Equity markets have fallen this years on account of the panic selling caused after the spread of COVID-19. That leaves gold in a sweet spot.

“Investments in SGBs let the government raise money at an attractive rate of interest at 2.5 per cent. This effectively helps the cash-strapped government in these testing times,” says Sen.

Relatively attractive

SGBs offer 2.5 per cent interest, payable half-yearly. This payment of interest is a good enough attraction in a falling rate regime, in addition to giving exposure to gold. SGBs are thus more attractive than gold exchange traded funds (ETFs). Gold ETFs do charge the investor an expense ratio, which eats into returns. Also, barring a few, most of them are illiquid and do not trade closer to their net asset value. If you decide to take the gold saving fund (mutual fund schemes investing in gold ETF) route, then it adds to costs, though it offers assured liquidity.

Improving liquidity on stock exchanges

Though the SGB has a tenure of eight years, investors have the option of surrendering the bonds early – after five years from the date of issue. The bonds are also listed on the stock exchange. Traded volumes are on the rise and the discount of the traded price to the current market price is shrinking.

Though the liquidity of SGBs on the stock exchanges is improving, you should be prepared to hold on to them till maturity. Another benefit of holding on is that the capital gains are exempt from tax. If you decide to sell in the secondary market, capital gains on SGBs held for more than three years, are taxed at 20.8 per cent. Otherwise, capital gains are taxed at your marginal rate.

As a collateral for loans

SGBs can be used as collateral to raise loan, especially if you hold them in demat form. The loan-to-value (LTV) ratio given is equal to ordinary gold loans. “As a loan against SGBs is secured, the investor can raise funds at 200 to 300 basis points lower interest rate compared to that payable on a personal loan,” says Gaurav Gupta, founder and CEO of MyLoanCare.in. “Compared to loan against shares or equity mutual funds, the LTV for SGB backed loans is higher,” he adds.

Should you invest?

Proportional asset allocation among equity, debt and gold is important.

Gold does look attractive when equity and debt markets turn volatile, especially in the present times, faced as we are with the pandemic.

“If you see rising uncertainties, gold and SGBs are good investment options,” says Sen.

Do not go overboard though. As the macroeconomic situation improves over the medium term, other asset classes too will appear attractive fundamentally.