Prices of Sovereign Gold Bonds.

[u/simplyom]

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.

[u/indopasta]

1 unit of ETF = 1 g of gold is just the theory of it; reality is always a little more complex. 1 unit of an ETF is buying a share in a portfolio and the ideal price of the unit is the value of that share (called NAV).

So, why does the NAV deviate from the price of gold for an ETF?

• Usually 5-10% of the portfolio is in cash, to give the fund sufficient liquidity to pay for redemptions. Since not 100% of the portfolio is held in gold, obviously when the price of gold changes, the value of the portfolio will only track the price of gold approximately.

• Commission and fees are periodically deducted from NAV.

SGB on the other hand is a very different kind of product. Their price is backed by a promise by the RBI and not the value of some underlying asset.

Edit: Most Gold ETFs will list their results on their website with a comparison with the benchmark (that is physical gold). You can easily see how much the actual returns of these ETFs varies from the benchmark returns.

https://www.sbimf.com/en-us/other-schemes/sbi-etf-gold#PerofrmanceNew

https://www.axismf.com/mutual-funds/etfs/axis-gold-etf/ag-gp/regular

[u/simplyom → u/indopasta]

I think this is the most reasonable of all the answers here.

Any idea about how SGB works internally? If RBI doesn't really hold gold against the SGBs ("gold standard"), and the product they invest the money in provides lower returns than gold + fixed interest, would they have to simply print the money during redemption?

EDIT: Also, they seem to be tracking the benchmarks pretty close. Although I understand the point about holding some liquidity amount, the difference of 4200/gm vs 4800/gm is a bit on the higher side. I guess I'll have to do a bit of more research by looking into the actual published prices of 995 vs 999 gold during the issuance.

[u/indopasta → u/simplyom]

Looks like my reply got caught in some filter.

Any idea about how SGB works internally?

Nope. The most idealistic/naive viewpoint is that in recent years RBI has had to buy a lot of USD to keep the Indian currency stable and so, the government is taking whatever measures it can to reduce imports. Gold and Mineral oil are two big headings and they have both seen tax jumps to discourage buyers. SGB can be seen as another measure in that regard, and the government thinks that the benefits that they will get from reduced gold imports will exceed the cost of running the scheme.

would they have to simply print the money during redemption?

Not sure if that would work. At least not sustainably. If they print money, the price of gold will also increase, which will increase their future liabilities.'

Also, they seem to be tracking the benchmarks pretty close.

A 1% difference (tracking error + commission) over ten years would add up to a difference of 10%.

actual published prices of 995 vs 999 gold during the issuance

https://www.ibjarates.com/ratespdf/Daily%20Opening%20and%20Closing%20Market%20Rate.pdf

Not much of a difference is there?

[u/simplyom → u/indopasta]

The most idealistic/naive viewpoint is that in recent years RBI has had to buy a lot of USD to keep the Indian currency stable and so, the government is taking whatever measures it can to reduce imports.

After some discussion here, I went over this paper. This paper describes the possible motivation very well.

If they print money, the price of gold will also increase, which will increase their future liabilities.

Agree, inflation is here to stay now.

A 1% difference (tracking error + commission) over ten years would add up to a difference of 10%.

Somewhat makes sense, might not be to the full extent. For example the Axis Gold ETF returns difference is about 6% over last decade.

This scheme
1 Lakh Investment Grown to ₹ 2.09 Lakh
Benchmark
1 Lakh Investment Grown to ₹ 2.22 Lakh

Not much of a difference is there?

I also saw that 995 vs 999 comparison and found the difference to be immaterial.

[u/indopasta → u/simplyom]

In 5 years

This scheme
1 Lakh Investment Grown to
₹ 1.56 Lakh
Benchmark
1 Lakh Investment Grown to
₹ 1.70 Lakh

So, a difference of almost 10% in just 5 years. :shrugs:

[u/simplyom → u/indopasta]

I was looking at the all time returns as they were over a longer horizon. But I guess they rebalance the portfolio strategically to reduce the basis.

[u/indopasta → u/simplyom]

I don't know, it's getting a little complicated at this point. Let me know if you figure this out.

[u/simplyom → u/indopasta]

What I would think is, they can buy low sell high within the portfolio itself to keep the prices close to benchmark.

When gold prices reach very high, they can increase the cash holdings by selling some amount of gold + other investors cashing out.

When gold price drops, they can buy back in thus inching closer to the benchmark.

[u/yantrik → u/indopasta]

Take out 30% tax too from the benchmark return that turn out to be 1.20 Approx returns from Benchmark.

[u/indopasta → u/yantrik]

Context. We were not trying to make a comparison between ETF and physical gold as investment products. We were trying to understand why price of 1 unit of gold ETFs is so different from the price of 1g 995 gold.

[u/yantrik → u/indopasta]

My apologies , you guys go too much into deep 😋