Gold bonds are 8 years old, but have they worked?

  • 04 Jun 2024
  • Read 8 mins read

Have sovereign gold bonds worked?

Since the first issue of sovereign gold bonds (SGB) in 2015, the question has been whether these SGBs are really delivering the goods. Today the value of Sovereign Gold Bonds (SGB) issued by the RBI as of date is nearly 3 times the AUM of gold ETFs. The reasons are not far to seek. In addition to capital movements, SGBs have the added advantage of regular interest payments. The value of underlying gold and the regular interest payments are fully guaranteed by the central government. In addition, this offers the benefit of gold in dematerialized form and the investor does not have to worry about the hassles of holding and managing physical gold. However, that brings us to the million-dollar question, of whether the Sovereign Gold Bond has actually delivered the goods in terms of performance.

 

Here is the proof of the pudding on SGB

One of the big advantages is that gold bonds are free of default risk, although the price risk is always there since the price of the SGB is linked to the underlying price of physical gold. Now, the first tranche of Sovereign Gold Bonds issued in 2015 will come up for redemption on completion of 8 years on 30th November 2023. How do we assess the performance of the first tranche of Sovereign Gold Bonds? Remember, the 8-year holding period is very important since once these bonds are held for the full 8 years, they are exempt from long-term capital gains tax. That is one of the reasons, the interim redemption window at the end of the fifth and sixth years did not see much of a response from the SGB investors in the past. 

How would the first tranche of gold bonds (up for redemption in November) have delivered on returns? Here is a small disclaimer. We do not know what would be the average price for redemption in November, so just to simplify things we will take the current price as the likely redemption price on November 30, 2023. The assumption is that the price of gold would not be too volatile between now and November 2023. The cost of acquisition of SGBs in the first tranche was Rs2,684/gram while the current price stands at Rs5,929/gram. In short, the price of gold bonds has appreciated 121% over the last 8 years or you can call it 10.40% CAGR returns purely on the price.

How will first tranche of SGB look post-tax?

As we know, the first tranche of the Sovereign Gold Bonds (SGB) is up for redemption on November 30, 2023 and extending today’s price to November, it works to CAGR returns of 10.40% on price over the last 8 years. But, how does that look in post-tax terms? The table below should explain that point.

Particulars

Amount

Explanation

Cost of SGB – Tranche 1Rs2,684/gramActual SGB allotment price
Price of SGB – in Nov-23Rs5,929/gramCurrent price extrapolated
Gains on SGB in 8 yearsRs3,245/gram 
Overall gains in % terms121%Point to Point price returns
CAGR Gains on Price10.40%8 year compounding
Tax on Capital gainsNilTax-free after 8 years
Post Tax Price Return (A)10.40% 
Annual Interest on SGB2.50%Assured Return on SGB
Tax on SGB0.75%Assumed at 30% tax flat
Post Tax Interest (B)1.75% 
Total annualized Yield (A+B)12.15%Overall returns post-tax

Data Source: RBI / CBDT

Based on our assumptions of stable prices of gold till November, the post-tax returns on the sovereign gold bonds (SGB) would have been 12.15%. That is an extremely attractive return if you compare with other classes of debt investments. But, how does the SGB returns compare with equity returns in the same period?

Did the equity bull market beat the gold market?

It needs no reiteration that the annualized post-tax returns of 12.15% on gold bonds are very attractive by any benchmark. More so, considering that this is a government-guaranteed product. Surely, that is better than any form of debt over the last 8 year periods, but how does this compare with equity market returns in the same period? During the same 8-year period, the Nifty is 2.9 times, if you look at the Nifty TRI index. The total returns index (TRI) factors in capital gains and dividends and is more reliable. 

If you look at the Nifty TRI index during the same period, the CAGR returns would be around 13.8%. However, these are pre-tax returns. Capital gains on equities are taxed at 10% above the Rs1 lakh threshold while dividends are taxed at the peak rate applicable. While we will not get into specifics, it is clear that if the Nifty has given attractive returns in the last 8 years, the SGBs have done equally well, with a much lower risk quotient.

Better to use gold judiciously as a hedge

However, it would be premature to go overboard on gold. Remember, unlike equities, SGBs have an 8-year mandatory lock-in, if you want to claim the capital gains tax exemption benefits. Secondly, we have seen gold prices appreciate in the last 8 years due to an overall miasma of uncertainty in the global markets. Trade wars, COVID pandemic and slowdown fears; all caused gold to be a preferred safe haven. This may not continue once the economic growth is back on track, which is why gold tends to operate in prolonged cycles.

The message is that gold still adds a lot of value as a natural hedge to your portfolio. An allocation of 10% to 15% to gold is a good idea as it is an asset that moves independently of financial asset classes and also is the best asset in times of economic uncertainty. Your exposure to gold in the portfolio can range between 10% and 15%. It may add limited value to go beyond that in terms of gold exposure.