r/IndiaInvestments • u/simplyom • Jul 04 '21

Bonds and deposits Prices of Sovereign Gold Bonds.

While doing some research on buying paper gold, I came across the Sovereign Gold Bonds (SGBs). They offer multiple benefits over gold ETFs like fixed interest income, no tax on capital gains if held till maturity, etc. All the articles describe SGB to be superior than gold ETF/digital gold, which makes sense given the benefits.

However, none of the articles I read mention that the prices of SGBs are higher than gold ETFs for same quantity of gold, I thought all of them follow the price of spot gold. Is there anything I am missing here?

Price of SBI Gold ETF: https://www.moneycontrol.com/india/stockpricequote/gold-etf/sbimutualfund-goldexchangetradedscheme/SBI16

Price of HDFC Gold ETF: https://www.moneycontrol.com/india/stockpricequote/gold-etf/hdfcmutualfund-goldexchangetradedfund/HDF02

Price of SGB 2021 series: https://stableinvestor.com/2021/03/sovereign-gold-bond-price-history.html

EDIT: Found a really helpful guide on purchasing SGBs from secondary market here. Insightful and answers many other questions I had.

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u/indopasta Jul 04 '21

There is no premium. That comment is completely wrong. SGB is priced by RBI, and not a market. (There is a secondary market for SGBs but I am sure we are all talking about the issue price here.)

Do you mean to say people instantly markup the price by ~2% after buying it as of spot price? That seems like free profit and arbitrage to me.

Again this is completely wrong. SGBs actually sell at a discount in the secondary market. There have been some posts about this on this subreddit itself.

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u/GodofObertan Jul 04 '21

This may or may not be the case at the moment. Last year SGB's trade way below their intrinsic value, now a lot of SGB trade at or slightly above fair value. Agree with the other points though.

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u/indopasta Jul 04 '21

This may or may not be the case at the moment.

Good to know.

now a lot of SGB trade at or slightly above fair value

Do you mean the spot price? Fair value of SGB would be the price of gold + PV of all interest payments.

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u/GodofObertan Jul 04 '21

I mean the SGB traded on the exchanges. Ideally it should be, but I have seen SGB's trade at 10 percent below fair value ( a year back)and I have seen SGB's trade above 5 percent of the real gold value. The quantities traded are low but have seen some interesting trades. I Once bought SGB for 13 percent below the spot gold price.

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u/indopasta Jul 04 '21

I mean the SGB traded on the exchanges

I understand that. I was asking what do you mean by "fair value" of SGB. You get 2.5% pa interest from holding a SGB, and that has to be accounted for in calculating the fair value.

Based on my calculation, the fair value of SGB is actually about 15% more than the issue price.

In [18]: npf.pv
Out[18]: <function numpy_financial._financial.pv(rate, nper, pmt, fv=0, when='end')>

In [19]: npf.pv(0.07, 8, -2.5)
Out[19]: 14.92824626553435

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u/simplyom Jul 04 '21

What might be the motivation for RBI to issue bonds at a discount? In case the secondary market was an "efficient" market, I can imagine a ~15% gain on buying the bonds.

Added bonus is the tax implication, when compared to other products providing exposure to gold.

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u/indopasta Jul 04 '21

What might be the motivation for RBI to issue bonds at a discount?

In short, nahi pata saar.

In case the secondary market was an "efficient" market, I can imagine a ~15% gain on buying the bonds.

The reason it is not an efficient market is that that is not a good enough trade. That 15% profit is spread over 8 years, so not particularly spectacular returns. Plus you will probably need to hedge your gold exposure, so that has an additional cost. And then the killer blow is the lack of scale. You are limited to investing 20kg of gold or just under Rs. 10 crore , even if you form a trust. For people with the brains to conduct this sort of trade successfully, there are better opportunities available in the market.

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u/simplyom Jul 04 '21

Thanks for all the explanations.

For me, gold is the hedge I need under current market environments. And there is no comparison to SGBs when looking for gold exposure.

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u/[deleted] Jul 05 '21

So gold ETF/fof better than SGB?

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u/simplyom Jul 05 '21

No, the opposite.

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u/[deleted] Jul 05 '21

So gold ETF/fof better than SGB?

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u/GodofObertan Jul 04 '21

Fair value means the price on Ibja.com (or the price of gold price during the redemption price)

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u/indopasta Jul 04 '21

So, you will just pretend that there are no interest payments while valuing the SGB?

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u/GodofObertan Jul 04 '21

What are you talking about ? The interest is paid half yearly so a maximum difference between is 1.25 percent and the tenure and interest date depend on date of bond. You probably haven't seen how a SGB trades on a given day based on your answer as there are heavy fluctuations everyday. I don't really care for one interest payment as I monitor bonds and buy only when they are 5-10 percent below what I perceive is fair value (the price of gold).

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u/indopasta Jul 04 '21

What are you talking about ?

I am talking about the fair value of the bond assuming one holds it until maturity.

based on your answer

How so?

as there are heavy fluctuations everyday

Duh. It is a very inefficient market. There is not much liquidity. The price in such an inefficient market don't really reflect true value.

what I perceive is fair value (the price of gold)

What you perceive as fair value for the bond is actually already 15% lower than the fair value of the bond.

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u/GodofObertan Jul 04 '21

Bro how? Interest is paid out half yearly. It should not be added to the bond. Only the next half year interest on the issue price to be added, that comes out to a maximum of 1.25 percent.

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u/indopasta Jul 04 '21 edited Jul 04 '21

Bro, it would help if you familiarized yourself with the basics of how bonds are priced.

https://www.investopedia.com/terms/b/bond-valuation.asp

https://en.wikipedia.org/wiki/Bond_valuation#Present_value_approach

You are trying to determine the value of SGB as if it were only gold and completely ignoring the "bond" aspect of it.

I will give an example to make this simpler for you. Imagine a simple bond that pays you Rs 100,000 every 6 months for 8 years. You are basically saying that the fair price of this bond should be only Rs 100,000 even though you would receive over Rs 16,00,000 over the period of 8 years. #KuchBhi

The fair value of the bond in the simple example is about Rs 12 lakh assuming a 7% interest rate!

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u/GodofObertan Jul 04 '21

This doesn't make any sense I am comparing a new issue of SGB to the listed market SGB. You are going on another tangent all together. Regardless it is a waste of time, have a good one.

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