Will Sovereign Gold Bonds Generate Investor Interest Ahead Of Akshaya Tritiya?
An employee arranges two hundred and fifty gram gold bars. Photographer: Akos Stiller/Bloomberg.

Will Sovereign Gold Bonds Generate Investor Interest Ahead Of Akshaya Tritiya?

BloombergQuintOpinion

The first tranche of Sovereign Gold Bonds (SGB) for financial year 2017-18 (and eighth in the series starting 2015-16) opened for subscription on April 24 and will close on April 28, a day ahead of Akshaya Tritiya, the auspicious Hindu calendar day when families purchase small quantities of the yellow metal as part of tradition.

The issue price of the upcoming bonds will be Rs 2,901 per gram, Rs 50 less than the nominal value of Rs 2,951, based on the simple average closing price – published by India Bullion and Jewellers Association for 999 purity gold – for April 17-21, 2017, the week preceding the subscription period

The tenor of the bond will be for a period of eight years with an exit option permitted from the fifth year of the date of issue. Liquidity is available from secondary markets as the bonds are mandated to be listed on the National Stock Exchange (NSE) and BSE.

A key attraction of the SGB scheme is the 2.5 percent per annum interest that the investment carries.

In contrast, physical gold is an unproductive asset that does not deliver any financial returns to the investor.

In addition to the interest on investment, these bonds carry a sovereign guarantee and do not entail any fund management fee or brokerage charges. There could be capital gains in case the price at the time of redemption is higher than the issue price. SGBs can be used as collateral for loans.

Announced as part of Union Budget 2015-16, the SGB scheme aims to develop a financial asset as an alternative to purchasing physical gold. India’s ravenous appetite for gold is legendary. The country is arguably the world’s largest importer with annual inflows of 600-800 tonnes valued at $30-35 billion.

Customers shop for jewelry inside the Dwarkadas Chandumal Jewelers store in the Zaveri Bazaar area of Mumbai, India, to celebrate the Akshaya Tritiya festival on April 21, 2015. (Photographer: Dhiraj Singh/Bloomberg)
Customers shop for jewelry inside the Dwarkadas Chandumal Jewelers store in the Zaveri Bazaar area of Mumbai, India, to celebrate the Akshaya Tritiya festival on April 21, 2015. (Photographer: Dhiraj Singh/Bloomberg)

Estimating Return On Gold In 5-8 Years

Although portrayed to have received a good response, the SGB scheme has attracted only moderate investor interest. Cumulatively so far, bonds worth Rs 6,000 crore – representing slightly less than 20,000 kilograms or 20 tonnes – have been issued. Considering the volume of physical imports, investor interest in SGBs can be described as tepid. For retail buyers, physical gold has an emotional connect, because it is not only an investment asset but also a consumption asset, and often substitutes currency.

What are the chances of success of the SGB Scheme 2017-18 and possible future tranches? For one, demonetisation in November last year has sucked out excess physical cash – often unaccounted – that was lying with people. More important is the outlook for gold prices five to eight years from now.

In other words, will SGB buyers enjoy capital gains at the time of redemption or will prices decline below the issue price and erode even the interest gains?

So, here’s the key question investors seek the answer to. Where would domestic gold prices be in a 5-8 year timeframe? While forecasting gold price is seldom easy, some pointers are available. Admittedly, the size of India’s population and traditional consumption habits will continue to drive demand for gold in the foreseeable future. However, with robust economic growth, rising income and education levels, the age profile of the population, rising aspiration levels, evolving lifestyles as also the availability of multiple investment options, the share of gold for investment purpose is likely to steadily decline.

If India’s economic growth aspirations materialise, the rupee may well be at 50-55 to the U.S. dollar five to eight years from now.

From the supply side, globally, with improved excavation and extraction technology leading to falling production costs, gold prices may come under downward pressure and trade well below $1,000 an ounce. In other words, there could potentially be a collapse of gold prices going forward. For SGB investors, timing the exit is critical.

G Chandrashekhar is an independent policy commentator and commodities market specialist. Views are personal.

The views expressed here are those of the author’s and do not necessarily represent the views of BloombergQuint or its editorial team.

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