The seventh sovereign bond (SGB) issue of financial year 2021-22, from the Reserve Bank of India (RBI), will close for subscription today. The issue opened for subscription on Monday October 25, 2021. Indians have demonstrated large appetite for gold around Diwali time. Gold imports hit a decade high level of $23.9 billion in the first six months ended September 30, 2021. However, gold prices are down in the last one year. Should you invest in the SGBs?
What’s on offer
The SGBs in Series VII will be issued at Rs 4,761. Each bond will track the price of one gram of gold. The nominal value of the bond is the simple average of the closing price of the last three business days. There is a discount of Rs 50 per bond if you apply using digital mode.
The tenure of the bond is eight years and, at maturity, investors are paid an amount equal to the one gram price of gold prevalent at that time. The gains are tax free if the SGBs are held till maturity. In addition, there is a coupon of 2.5 percent payable semi-annually on the nominal value. The interest earned is taxable at the slab rate of the investor. These bonds are traded on the stock exchanges.
What drives gold prices?
Gold prices have been extremely volatile in the last two years. After increasing in the first half of CY2019, they have been languishing for the last one year, and are down 4 percent. The recent rally in gold prices may indicate a possible course correction.
Also read | Explained: The factors that affect gold prices
A recent report from the World Gold Council (WGC) states that for each one percent rise in the income of buyers, gold prices rise 0.9 percent. Gold price levels have a negative correlation with the demand for gold. For each one percent hike in price of gold the demand decreases by 0.4 percent.
“The release of the pent-up demand following the easing of lockdown restrictions and re-opening of retail outlets, the revival in consumer sentiments due to the steady progress in vaccination, the declining risk of a third COVID wave along with re-stocking of inventories ahead of the festive and wedding season have led gold imports to surge in FY22 so far,” says Suman Chowdhury, Chief Analytical Officer, Acuité Ratings.
Inflation and the resultant negative real interest rates (nominal rate of interest less inflation) influence gold prices. Gold is seen as hedge against inflation. For each one percentage point increase in inflation, gold demand increases by 2.6percent, as per WGC.
Gold did well initially as pandemic spread across the world and the central banker responded with rate cuts. However, things are changing now. The US Federal Reserve has made it clear that by end of this year, it may announce tapering and it will be done with tapering by mid CY2022. Rising interest rates and tightening liquidity in USA is positive for US dollar. A strong dollar traditionally indicates weak gold prices. “Gold prices are expected to get a boost from inflation concerns, but at the same time, a recovery seen in the economy from the pandemic and hawkish stance adopted by the US Fed could keep gains in check,” says Navneet Damani, Head Research-Commodities and Currencies, Motilal Oswal Financial Services.
Gold is also in demand when economic growth is weak. “Though stock markets are rallying and macro-economic outlook is positive, higher inflation, dissipating growth, and potential effects of tapering are risks,” writes Chirag Mehta, Senior Fund Manager- Alternative Investments, Quantum AMC in his recent note on gold outlook. Higher inflation could hurt consumer demand and slow down the economic recovery. As interest rates and inflation inch up, they could result in stock market volatility, as corporate profitability would be hit.
Asset allocation matters
Investors and advisors are careful about their portfolios after almost 18 months of strong gains. “There is no immediate trigger for gold prices to go up. As long as stocks keep rising, gold may not move up much. However, a fall in stocks may push investors to buy gold to hedge themselves against volatility. That can send the gold prices up,” says Vinayak Savanur, Founder and CIO, Sukhanidhi Investment Advisors. His advice for investors is to allocate around 5-10 percent of their corpus to gold for asset allocation purpose through sovereign gold bonds.
Damani expects gold to trade sideways with a bullish bias. “In the current scenario, gold on the Comex is seen at around $1860- $1900. Whereas, on domestic front, Rs. 49,700- 50,500 per 10 gram looks possible,” he says.
We are at a juncture where easy money in stock markets is probably behind us. As interest rates move up along with inflation, ignoring gold may prove costly for investors.
Should you invest in SGBs?
SGB is an interesting investment vehicle for long-term investors who want to diversify their portfolios. Investing in SGBs can be considered if one is prepared to hold till maturity.
Though the liquidity on the stock exchanges has improved in the recent past, there is no assurance that they can be traded near fair value, especially when the gold is out of favour. You can also sell it back to the RBI after holding it for five years after issuance.
Savvy investors can also check existing sovereign gold bonds listed on stock exchanges. You may get to buy some bonds at a discount to the prevailing price in the current issue. You should place limit orders to acquire those. However, do check the residual tenure of these bonds and see if it suits your investment timeframe. Do not forget to account for the transaction costs as well.