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Should you purchase discounted SGBs on the exchange?

05 Sep 2022 0 COMMENT

Introduction

Owing to its spiritual and cultural importance, gold has traditionally been loved as an investment choice in India. While investors look to diversify their holdings across other asset classes, gold prices have witnessed a steep rise since 2019. The cost of one gram of 24 karat gold was about Rs 3,200 in 2019, which is Rs 5000 at present, an increase of almost 56% seen in two years.

The increased demand for gold and gold assets is visible. One can invest in gold in a variety of ways, including physical gold (such as jewellery, coins, bullion, etc.), gold mutual funds, gold exchange-traded funds (ETFs), digital gold, or sovereign gold bonds (SGBs). Today, we’ll talk about SGBs and what you should know before purchasing them in financial markets.

Sovereign Gold Bonds are financial securities having gold as their underlying asset, making them a form of gold investment issued by the RBI on behalf of the Indian government. A bond unit is equal to 1 gram. In addition to the offer made while it is available for subscription, such as when SGB 2021-22 Tranche 4th was open, you could also purchase it on the secondary market precisely like a stock.

SGBs offer attractive returns compared to other gold investment options as they pay the yellow metal's value and an additional interest rate at maturity. However, this is only true if you are a long-term investor.

Additional read: How Sovereign Gold Bonds Score Over Physical Gold

The Secondary Market Is Where the Difference Exists

There are two ways to purchase SGBs, directly from the RBI through its primary issuance or indirectly through credible stock exchanges, such as the NSE and BSE.

However, on stock exchanges, SGBs trade at a discount to the spot price of gold. This disparity mainly results from the exceedingly low trading volumes on the stock exchanges.

The forces of supply and demand determine the prices of SGBs exchanged on the secondary market, just like they do for any other active public security. Besides the fact that there isn’t a lot of liquidity for these securities, demand and supply dynamics also matter. These elements cause the SGB bond prices to diverge from gold spot prices.

Price changes are a result of a lack of demand. Despite being marketable on exchanges, the bonds’ low levels of liquidity due to their structure may cause them to trade at a discount.

Investors who want to make an early exit should closely monitor trading volumes, trading prices, and actual gold prices because SGBs are also traded on the exchange.

To avoid incurring an unnecessary capital loss while redeeming SGBs due to the trading price and actual price mismatch, we encourage investors to wait for the SGB trading price to catch up with the actual gold price, or at least wait for the RBI’s SGB repurchase window, which occurs from the fifth year onward.

Additional read: Why Invest in Sovereign Gold Bonds?

Should you purchase SGBs in the secondary market?

Investors shouldn’t base their decision to purchase SGBs solely on the secondary market’s discounted prices.

Different tranches of SGBs have varying maturities. According to experts, only investors who can retain their investment until it matures should consider purchasing SGBs in the secondary market.

If you withdraw your money before the secondary market reaches maturity, you can encounter the same problems with pricing inefficiencies from which you are currently benefiting.

The tax benefit on the SGB gain that would otherwise be available if held until maturity may also be lost. Any capital gains are tax-free if you keep the bonds until they mature. If held for more than 36 months, indexation benefits apply to the 20 percent capital gains tax on prematurely sold SGBs in the secondary market. Short-term capital gains are taxed at the individual income tax rate.

Takeaway

You will receive a guaranteed interest rate and tax-free redemption proceeds if you can keep your SGBs until they mature. You won't need to worry because the redemption price offered by RBI at this time will be equal to the spot gold price.

A great way to integrate gold as an asset class in your portfolio is through sovereign gold bonds. However, before you invest, be sure to learn everything there is to know about them.

DisclaimerICICI Securities Ltd.( I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Centre, H. T. Parekh Marg, Churchgate, Mumbai - 400020, India, Tel No : 022 - 2288 2460, 022 - 2288 2470. I-Sec is a SEBI registered with SEBI as a Research Analyst vide registration no. INH000000990. AMFI Regn. No.: ARN-0845. Mutual Fund Investments are subject to market risks, read all scheme related documents carefully. Please note, Mutual Fund related services are not Exchange traded products and I-Sec is just acting as distributor to solicit these products. I-Sec is acting as a distributor to solicit bond related products. All disputes with respect to the distribution activity, would not have access to Exchange investor redressal forum or Arbitration mechanism.  The contents herein above shall not be considered as an invitation or persuasion to trade or invest.  I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. Investments in securities market are subject to market risks, read all the related documents carefully before investing. The contents herein mentioned are solely for informational and educational purpose.