Are sovereign gold bonds the new ‘gold standard’ in investing?

Even over a longer term, since 2012, while gold prices have increased 2.25 times, the Nifty 50 has gained 4.25 times. This is despite assuming that dividends from Nifty 50 are not reinvested back in the index. 

However, gold has delivered superior returns in another space: sovereign gold bonds.

SGBs are issued for a term of eight years, but are redeemable after five years. These bonds are issued and redeemed at the prevailing gold price, which allows for investing in gold without holding it in physical form. 

Further, SGBs pay interest of 2.5-2.75% per year. While interest receipts are taxed, capital gains on redemption are not.

The government has issued 67 tranches of sovereign gold bonds since 2015.

The first four SGB series, issued between 2015 and 2016, began to be redeemed in full last year after their eight-year tenure. Their final returns fell short of Nifty 50, after adjusting for tax on Nifty 50 dividends and assuming such dividends were not reinvested back into the index. 

However, the subsequent SGB series, eligible for early redemption after five years, have often beaten the Nifty 50. Overall, of the 30 SGB series eligible for redemption so far, returns from as many as 21 till their latest respective redemption date have topped Nifty 50 returns.

Brisk demand

The central government has raised ₹72,264 crore through sovereign gold bonds since 2015. This issuance is backloaded, with ₹46,000 crore of the total amount being raised since 2021-22. 

The latest two SGB issues, made in December and February, raised about ₹15,500 crore cumulatively. In other words, these two issues accounted for about one-fifth of the total SGB collection from the 67 issues so far.

Given that annualized returns on gold bonds are running at 16-19%, prices of gold bonds on the secondary market have soared. The price of the SGB issued in December has risen by about 29% since January. The bonds issued in February have been even more lucrative, giving the same returns since March. 

Adding to demand is investors’ perception that the government may slow down on the issuance of such bonds, given the high excess returns it has to pay on them.

Duty cuts

On 23 July, Union finance minister Nirmala Sitharaman announced a cut in the customs duty on gold and silver, from 15% to 6%. The move represented a reversal of successive increases in customs duty on gold—from 2% in 2012 to 15% in July 2022. 

According to data from the World Gold Council, the recent duty cut is the sharpest during this period, and takes customs duty rates to January 2013 levels.

One objective of the rate cut was to reduce gold smuggling. Gold prices surged in the immediate aftermath, then fell, but have been rising again. Cumulatively, over the past month gold prices have risen by about 5%. Sovereign gold bond prices have followed suit. The duty cut is expected to spur demand, especially ahead of the festival season this year. The expectation is that gold bond prices will rise further from current levels.

Bullish outlook

The four tranches issued in 2015-16 have matured fully and been redeemed. The government paid ₹5,147 crore in redemptions (excluding interest on the bonds while in force), against the ₹2,238 crore that it had raised.

Another 26 tranches of sovereign gold bond issues have crossed the five-year mark and are eligible for early redemption. However, as the gold bonds have become progressively more lucrative, investors have mostly opted to hold onto those bonds, with only ₹786 crore being redeemed. 

In each of these 26 series, the total units redeemed is less than 10% of the units issued. The 2019-20 series has barely seen any redemption. That says a lot about how gold is currently viewed as an investment option.

www.howindialives.com is a database and search engine for public data.