Do sovereign gold bonds bought in secondary market make good investments?

SGBs are not very liquid. Buy only if you believe gold prices will remain strong and if you can hold till maturity; if you're a short-term investor, ETFs work better

Gold has been in the limelight during CY2019 with returns over 20 per cent. Investors are keenly eyeing gold as an investment option in one form or the other, be it in physical or digital gold–gold exchange traded fund (ETF), fund of funds investing in gold ETF or through sovereign gold bonds (SGB).

As physical gold does not give any interest or dividend, fans of ‘regular income’ prefer SGB over bullion and gold ETF. However, SGB issuances are not available round the year. Either you have to wait for a new issue or buy it from the secondary market. If you are keen to take exposure to gold via SGBs, is it a wise to buy from the secondary market?

SGB in a nutshell 

SGBs are issued by the RBI on behalf of the Government of India, and each bond is expected to track the price of one gram of gold. The bonds are issued for eight years, though they can be encashed or redeemed on the interest payment dates after five years from the date of issuance. The bonds pay interest at the rate of 2.5 per cent per year – payable semi-annually. SGBs come with a sovereign guarantee and are listed on the stock exchanges. The bonds are tradable if held in demat form and transferable to other eligible investors.

Is it attractive investment?

To put it straight, SGBs will do well if gold prices remain strong. Commodity experts feel there are multiple drivers which will lead to firm gold prices. “Geo-political tensions, precarious recovery in global growth, dovish stance by major central banks, rise in negative yielding assets, a perceptible de-dollarisation in economies like China and Russia are positives for gold. With deflation lurking around the corner, the Fed may go for more rate cuts which are expected to sustain the momentum in gold prices. Hence, investing in SGBs can be a wise decision for a conservative investor,” Alok Agarwala, Head, Research & Advisory, Bajaj Capital, said.

If you believe gold prices will go up, then you should have exposure to the yellow metal as an asset class. “There is room for a 10 per cent increase from current levels in 2020. A host of uncertainties like macro-economic shifts in global markets, low global growth followed by easy monetary policy of central banks, US-China trade war, geopolitical risks and uncertainties, Brexit, inflows into ETFs, gold as an asset class will be favoured by investors in 2020,” Prathamesh Mallya, Chief Analyst, Non Agri Commodities and Currencies, Angel Broking said.

Should you buy SGB?

SGBs are listed on both BSE and NSE. Since they were issued from time to time over past few years, there are many series of SGB. These bonds are not liquid and only few get traded on most days. Most series are dry for want of volumes.

SGBs are long-term instruments. One has to be mentally prepared to hold on to them till they mature. If you have a trading mindset then avoid investing in SGB as you may not get exit at fair value on the exchange. “Although SGB's are traded in the secondary market, one has to be careful as price and liquidity risk exists in this market. There may not be enough buyers for the quantity offered and even the price might be lower,” Mallya warns.

Currently, SGB trade on the exchanges at discounts ranging from 3-10 per cent to the gold prices in spot market. If the situation does not change then you too may have to sell the SGB at such a discount if you decide to exit before maturity.

“Investors need to be wary of the abysmally low liquidity associated with SGBs. In fact, liquidity induced price discount is like a double edged sword. While attractive valuations can entice you into enter, finding a profitable exit can be a difficult proposition. What’s more, if the bonds are sold before maturity, capital gains tax will apply. It is therefore, recommended to stay invested till maturity,” Agarwala said. 

SGB or gold ETF?

If you are keen to buy gold for a year or two and want to trade in it, then gold ETF is a better option. If you are keen to buy large quantities and worried about liquidity in gold ETF units, then you can also buy fund of funds investing in gold ETF units. They guarantee exit at net asset value, though at slightly higher expenses. “For investors who always want liquidity, gold ETFs are a better bet. For those who can afford to hold till maturity, SGBs are surely a better option,” Agarwala said.

Investment features of SGB, gold ETF and physical gold
Particulars	SGB	Gold ETF	Physical gold
Scope for capital appreciation	Yes	Yes	Yes
Interest	Yes @ 2.5% p.a.	No	No
Sovereign guarantee	Yes	No	N/A
Liquidity	Tradable on exchanges; Redemption permitted after 5 years	Highly liquid	Good liquidity
Storage/ Insurance charges/ Quality check	No	No	Yes
Source: Angel Broking