Buy gold bonds at a discount on exchanges, but hold them until maturity

SGBs are better for taking exposure to gold than exchange-traded funds

Around a week ago, the domestic gold price hit its all-time high of Rs 34,450 per 10 gm. Though it corrected by around a percentage point on Monday, returns from gold have improved in 2019. In the past month, the domestic gold price was up 4.8 per cent and 6 per cent in the past three months.

And with the government offering the sovereign gold bond (SGB) for subscription at Rs 3,196 a gm last month, those who invested in the issue would be sitting on a 5 per cent notional gain as of Monday. But if you missed the rally and the SGB issue, you can still buy the yellow metal at a discounted price on the stock exchanges, where the previous SGBs are available at a discount of 3.4-8.2 per cent to the prevailing gold price of Rs 3,353.8 a gm. “The previous tranches of gold bonds are selling at a discount on the exchanges because there is a liquidity problem. A seller cannot get the prevailing market price due to the longer lock-in period, and hence has to lower it,” says Kishore Narne, head, commodities and currencies, Motilal Oswal Financial Services.

Apart from the discounted 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 an SGB carry an annual interest rate of 2.75 per cent on the existing price. They are more frequently traded on the exchanges. According to the data from the BSE, the number of bonds traded can be between one and 99.

SGBs are better for taking an exposure to gold than exchange-traded funds and the physical form as they come with an annual interest rate of 2.5 per cent. But do not rush to buy these bonds on the exchange only because of the discount and rising gold prices. Buy them only if there is a need in your portfolio. Investment advisors and wealth managers suggest that the allocation to gold should be 10 per cent of the portfolio.

Avoid taking arbitrage opportunities in the listed bonds. Investors need to understand if they buy these bonds at a discount, they will also need to sell them at a discount to the prevailing price of gold. The secondary market for SGBs is not vibrant. There are limited trades, due to which an investor has to take a hit if he wants to offload them. Another reason for the discount is the tenure of these bonds.

“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,” says Jayant Manglik, president, Retail Distribution, Religare Broking. According to Manglik, in the past 30 years, gold has offered about 6 per cent returns. If the investor remains invested through the tenure of the bonds, he would make similar returns over the long term in addition to 2.5 per cent annual interest that the government pays.