Sovereign gold bonds (SGBs) have been attracting a lot of interest lately, after the first set of the bonds matured in November. Investors who bought SGBs in 2015 at a face value of ₹2,584 per bond have seen the maturity value zoom to ₹6,132 with a rise in market prices of gold.

This works out to an annualised return of about 10.8%, on top of the annual interest of 2.75% the SGBs have paid. This is an exceptional return for a government-backed instrument.

But, if you are planning to invest in SGBs in the hope of 10%-plus returns, hang on. You may need to tone down return expectations and weigh the pros and cons of SGBs against other gold investments.

Volatile returns

SGBs are Government of India borrowings denominated in gold. The bonds are issued at a face value pegged to the prevailing market price of gold. At maturity after 8 years, they are redeemed at the gold prices prevailing then.

SGBs score over physical jewellery or bullion on ability to deliver gold returns transparently, based on the prevailing market prices of gold. With jewellery or physical bullion, you incur making charges, GST and other costs at the time of purchase and again suffer deductions such as wastage, when selling it back to the jeweller. The costs eat substantially into returns even if gold prices have zoomed during the holding period. With SGBs you get prevailing gold prices sans deductions.

But returns from SGBs (like from physical gold) are highly dependent on movements in gold prices between buy and sell dates. Also, the bonds pay a nominal interest on face value, which used to be 2.75% earlier, but has been set at 2.5% now.

Many Indians believe gold prices rise every year. In reality, they move up and down and do not even manage a gain every year. Between 2015 and 2023, Indian gold investors faced two years of losses (8% fall in 2015 and 4% drop in 2021) and two years of lower-than fixed deposit returns (3% and 7% in 2017 and 2018). But bumper years like 2019 and 2020, when gold prices added 20%-plus, lifted the average return to 10.8%.

For these investors, price returns on gold originate from two sources — movements in the international price of gold (because most of the gold consumed in India is imported) and the movement of the rupee against the U.S. dollar (a weaker rupee adds to the import price). Swings in these two components make for a volatile combination. On an average, rupee depreciation has contributed 2-3% to the returns from gold. Should gold prices stay put or the rupee appreciate against the dollar, this can mute returns from SGBs.

Unlike in equities, your ability to hold gold for a long period does not necessarily improve returns. A long-term rolling return analysis of gold from 1990 to 2020 showed that over 10-year holding periods, it offered less than 10% returns about half the time, while it returned over 12% about 40% of the time. This suggests you cannot rely heavily on SGBs to create wealth.

Unpredictable moves

Gold-price gains are far from even. It tends to rise sharply over a few weeks or months and retreat equally quickly. Price spikes are usually triggered by global events such as a financial crisis, geopolitical tension or flare-up in crude oil prices. As the events are tough to predict, it becomes difficult to tell when gold will perform.

To maximise returns, buy when prices are ruling low and sell after they have shot up on some external trigger. This is a habit that Indian jewellery buyers have honed over time. But with SGBs, practising the strategy is difficult as the timing of buys or sells is not in your hands. SGBs are sold and redeemed during limited windows of time decided by the Reserve Bank of India.

Liquidity

Unlike physical gold or gold Exchange Traded Funds (ETFs) you cannot cash out of SGBs at a time of your choice. SGBs, once sold, are traded on the exchanges. But they tend to feature low trading volumes, making exit difficult. For an assured exit, you may need to wait for 5 years, after which RBI offers to buy them back at a fixed price. Or, you need to wait until maturity date 8 years later. Gold ETFs, in contrast, can be bought or sold at any time. But they don’t pay interest. They also entail an annual management fee which you don’t incur with SGBs.

For individuals, SGBs bought from RBI and held until maturity are exempt from capital gains tax. But all other forms of gold investments – jewellery, gold ETFs – are subject to short-term capital gains tax if held for less than 36 months and long-term capital gains tax if held longer.

But returns from SGBs are highly dependent on movements in gold prices between buy and sell dates. Also, they pay a nominal interest on face value.

You can’t cash out SGBs at a time of your choice. Once sold, the bonds are traded on the exchanges. But, they tend to feature low trading volumes, making exit difficult

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