Discount or not, go for sovereign gold bonds if you can wait till maturity

The new series of the Sovereign Gold Bond (SGB) scheme is open for subscription from January 14-18. The face value of the bond is Rs 3,214 per gram. If an investor makes an online payment, there's a Rs 50 discount and they could get each bond for Rs 3,164 a gram. But what if you can get an SGB at an 8 per cent discount for, say, Rs 2,957 per gram?
 

Instead of investing in the new SGB issue, you can buy an older one on the stock exchanges at a discount ranging from 3.5-13.0 per cent. "The previous tranches of gold bonds are selling at a discount on the exchanges, given there is a liquidity problem. A seller cannot get the prevailing market price and hence has to lower it," says Nikhil Kamath, co-founder of Zerodha. 

Apart from the lower price, bonds issued earlier have another advantage. The period of holding them to maturity is also lower. SGBs come with a tenure of eight years. "The initial issues of SGB carry an interest rate of 2.75 per cent. They are more frequently traded on the exchanges," says Prateek Pant, co-founder and head (products and solutions), Sanctum Wealth Management. 

Other than the liquidity issue, these bonds are also selling at a discount because of global factors, such as the US Fed raising interest rates and the dollar remaining strong, according to Kamath. The yellow metal was up 8 per cent in CY2018 in India, and has gained 2.2 per cent in 2019 (within 15 days). Many analysts don't see further upside. 

While prices in the secondary market (on the exchanges) seem attractive, the traded volumes of SGBs are quite low. Brokers and wealth advisors say that volumes of the most sought-after bonds — those bearing a 2.75 per cent interest rate — are between 300 and 600 on a daily basis. Transaction volumes of other issues are in single digits. 

SGBs are better for taking exposure to gold, in comparison to exchange-traded funds and the physical form. However, don't rush to buy SGBs for the discounts. 

"First, evaluate if you need additional gold in your portfolio. We advise up to 10 per cent allocation to gold in a portfolio. Investors should buy these bonds only if there's a need for additional allocation to the metal," says Devang Kakkad, head (research), Equirus Wealth Management. 

Avoid taking tactical exposure or looking for arbitrage opportunities in the listed bonds. "An investor is getting them at a discount on account of mispricing. The mispricing will not get corrected on its own. If you buy to sell these bonds on the exchanges later, you might have to sell them at a similar discount," says Kakkad. Pant echoes similar views. "Buy these bonds in the secondary market only if you want to hold them till maturity. Only then will you be able to realise profits," he says.
 

Selling them in the secondary market will also attract capital gains tax. But SGB investors who hold them until maturity are exempted from the same.