Gold sovereign bonds generally trade below the issue price on stock exchanges; Should you be worried?

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

An SGB investor recently wrote to Outlook Moneyclaiming he subscribed to Series IX January 2022 (SGBJAN30IX) of the SGB issue and was surprised when his account statement showed negative returns in March as the value of gold rose during the period.

He had invested in 1 unit (1 gram) of SGBJAN30IX at Rs 4,736 via online mode on January 19. The gold futures price 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 gram on a day when gold prices were at Rs 5,137.9 per gram on MCX.

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

Investor fears, however, may be unfounded if they do not consider exiting before the five-year exit window. This is because the trading price does not reflect how the value at maturity of SGBs is calculated.

All SGBs carry an interest rate of 2.5%, payable semi-annually, and have an eight-year term with a repayment option from the fifth year. These bonds are offered at a discount of Rs 50 from the price at the time of issuance. The price of new issues is determined as the simple average of the closing price of 999 purity gold published by the India Bullion and Jewelers Association Limited (IBJA) for the previous week.

The distinction occurs in the secondary market

SGBs can be purchased in two ways: through primary issuance by RBI and in the secondary market on recognized exchanges such as the NSE and BSE.

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

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

“For SGBs traded in the secondary market, prices are determined as any active public safety 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. “Demand and supply dynamics also play a role, and there is not too much liquidity present for these instruments. These factors cause SGB bond prices to differ from actual gold prices,” Srivastava adds.

“Lack of demand affects prices. Although they are tradeable on an exchange (i.e. secondary market), low levels of liquidity due to their structure could potentially cause the bonds to trade at reduced prices,” says Ghazal Jain, fund manager, alternative investments, Quantum Mutual Fund.

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

“Since SGBs are also exchange-traded, investors who wish to sell prematurely should closely monitor trading volumes, the trading price and the actual price of gold. Lack of liquidity can be a major concern, and I advise investors to wait for the trading price of SGB to catch up with the actual price of gold, or at least wait for the RBI buyback window of SGB which occurs from the fifth year, so as not to unnecessarily incur capital loss when redeeming SGBs due to 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, RBI also gave investors the option to redeem their SGBs at the prevailing price calculated by them. For example, the price of gold on February 8 on MCX was Rs 4,830 per gram, and the RBI set early redemption for SGB at Rs 4,813. The cost of production will be deducted from this figure. In addition, you would have received interest semi-annually for the past five years.

“While SGBs pay annual interest and are tax-efficient, they have low liquidity (due to an eight-year term with a fifth-year exit option),” says Jain.

AMS are a long-term investment instrument

SGBs are suitable for long-term investors who want to invest in gold while benefiting from a fixed interest rate. If you have invested in SGBs you should ideally hold them to maturity as redemption proceeds are tax exempt under 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 to maturity and want exposure to gold without physically buying it. In addition, SGBs are backed by the sovereign. Thus, investors do not have to worry about its purity and inventory, and can invest without any stress,” says Desai.

If you can hold your SGBs to maturity, you’ll benefit from a guaranteed interest rate and tax-free redemption proceeds. At this point, the redemption price offered by RBI will be the same as the spot gold price, so you have nothing to worry about.

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