Sovereign Gold Bond scheme a good hedge against rupee, rising inflation

The Sovereign Gold Bond (SBG) Scheme 2020-21 series has its seventh tranche (SBG 2020-21 Series VII) open and running till Friday. There will be another issue next month. If bought online, this tranche is offered at Rs 5,051/gram with a discounted price of Rs 5,001. The current spot price of gold is Rs 5,055.

The SBG has an eight-year maturity period, with redemption allowed after five years. It offers interest unlike the physical metal and it’s dematerialised, which takes care of storage. It has fair liquidity.

The bonds are traded in the secondary market. However, this is usually at substantial discounts to the India Bullion and Jewellers Association Ltd. (IBJA) rates for .999 purity gold, which is underlying. Loans are readily available against the SBG. The bond offers a 2.5 per cent interest calculated on the subscription price. This has interesting implications.

If you think gold is a good investment, the SBG is a good way to get exposure. Apart from subscription to the primary issue, it is possible to pick up the 40-odd previous issues on the secondary market. That may be a discount to the current price. Redemption for some of the earlier series start in 2023. So, you could lock in a reasonable profit in theory. However, many of the tranches are not liquid in the secondary market.

If you’re subscribing to a primary issue, you’re taking a call on the price of gold in eight years, or rather in five years, when the exit is allowed. Historically, gold is seen as a haven in times of uncertainty, and as a hedge against inflation. It holds up well during inflationary periods, and during the crisis.

That pattern is unlikely to change. Gold did well after both the 2008 Subprime crisis and the second global financial crisis in 2011-12. It had a terrific run between April 2020 and early August, with prices gaining 25 per cent in just four months. It has seen a correction of about 2 per cent since.

The Covid-19 crisis is certainly not over. The pandemic will ease-off only when there’s an effective vaccine, and who knows how long that could take. Quite apart from the pandemic, there’s Brexit and a battered global economy, which will try to find new, socially distanced ways to do business. Uncertainty is guaranteed for the next couple of years at least.

Another point to note is that gold is a good hedge against rupee weakness. International prices are dollar-denominated. If the rupee weakens, that factors automatically into the gold price. A third point is that gold tends to keep pace with, or outpace inflation. India’s pattern of low growth and rising inflation could in itself set up a bull-run since India aggregates to a substantial player in the global gold market.

So there’s an argument for buying some gold. Coming to secondary market dynamics, there are also arbitrage possibilities. If you buy a tranche at a discount in the secondary market, and hold till redemption, you could get a decent return, assuming the price rises of course.

Interest accrual being calculated on subscription price is also worth examining. In 2019-20, subscription prices were between Rs 3200-3900/gram, with interest paid at Rs 80 and Rs 97.5 per gram, respectively. The 2020-21 series IV and V were issued at Rs 4800/gram (interest of Rs 120) and Rs 5,334/gram (Rs 133.35) respectively. The differences are substantial. Since the underlying is the same for all series, this sets up many possible arbitrages.

 Devangshu Datta is an independent market analyst. Views are his own.