Understanding RBI’s New Sovereign Gold Bonds Scheme

The Government of India announced that it will go ahead with the issue of the Sovereign Gold Bonds (SGBs) to domestic investors in 6 tranches that begin on 20th April 2020.

Crux of the Matter

What are SGBs?
It is government security that is a promissory note backed by Gold. Buying these gold bonds is like owning gold, not physically, but on a piece of paper. And because it is backed by the Indian government (or by any government), it is called a ‘sovereign’ bond. These bonds can be purchased via banks, designated post offices or online. The bonds have a maturity period of 8 years. These are the 6 windows or tranches in which you can buy the SGBs:

  • April 20-24, 2020; Date of Issuance (DoI) April 28, 2020
  • May 11-15, 2020; DoI May 19, 2020
  • June 08-12, 2020; DoI June 16, 2020
  • July 06-10, 2020; DoI July 14, 2020
  • August 03-07, 2020; DoI August 11, 2020
  • Aug.31-Sept.04, 2020; DoI September 08, 2020

Here are some important things that one should know about while buying these bonds:

  • The denomination of the bond is in grams of gold.
  • Minimum investment permitted is 1 gram of gold.
  • An individual can buy a maximum of 4 kilograms of SGBs. It would include purchases made from the tranche as well as purchases from the secondary market.
  • These bonds will give an interest of 2.5% every year. It will be paid semiannually and added to the investors’ income and taxed according to their income level.
  • The price of the bond will depend upon the simple average of the closing price of 999 purity gold in the last three working days. This means that the redemption price of the price at which you want to sell back to the government will also depend on the simple average of the last three working days.
  • The bonds will be tradable on the exchange after a week of the date of issuance.
  • These 8-year bonds will have an option of exiting after 5 years.
  • If investors buy these bonds online or through digital mode, they get a discount of ₹50/gram.
  • If you hold these bonds till maturity, then the capital gains would be tax-free.
  • These bonds can be used as collateral for loans.

Is There any Upside to Buying SGBs?
If your grandmother or mother emphasized on buying gold from savings, then they probably understood that investing in gold could be the safest investment that time has taught. However, storing huge quantities of gold is risky. If you have bought these bonds, there is no risk of your gold getting stolen. Compounded annual return on gold has been nearly 10% as compared to return from Dow Jones, 8.4%.

Gold seems to be one of the best bets around at a time when the coronavirus pandemic is creating havoc. However, one’s portfolio should not have too much of gold investment, 10% of the portfolio seems good enough. One aversion that investors might have while buying SGBs could be the price trend of gold. Although the future of gold seems promising, you never know. For instance, gold prices in 1979 rose by 120%, and then 29% in the following year. However, the year after, it lost 32% and never rose to the previous level until 2006 – 26 years later.

  • A commodity-backed bond is an investment whose value is directly related to the price of a specified commodity(in this case, GOLD). Unlike most bonds, a commodity-backed bond will experience fluctuations in value because of its basis on the price of the specified commodity.
  • On February 20, 1895, J.P. Morgan & Co. led a bond offering that helped rescue the United States from a severe two-year economic depression. In an effort to shore up the U.S. gold reserves, J.P. Morgan & Co. formed a syndicate in 1895 to sell $65 million in gold bonds for the U.S. Treasury.
  • At Berkshire’s 2018 annual meeting, Warren Buffett compared $10,000 invested in stocks and gold in 1942 (the first year he invested in stocks). That money invested in an S&P 500 index fund (there were none at the time, he noted) would’ve been worth $51 million in 2018 while a gold investment would’ve been worth only $4,00,000.