Physical gold vs SGBs: Which generated more wealth for investors since launch of gold bonds?

SGBs i.e. Sovereign Gold Bonds are financial instruments derived from the concept of fixed income bonds. The additional characteristic of SGB is that they are backed by gold. One unit of SGB represents one gram of gold and derives its value from the same. Furthermore, SGBs offer investors an opportunity to earn income on the underlying gold value. SGBs are backed by the central government and offer investors an interest income of 2.5 per cent of the face value of the bond issued. Thus, in comparison to the investment in physical gold, SGBs weigh better. 

Let us understand and compare the overall profit earned by holding 10 grams of physical gold v/s 10 units of SGBs: (In INR) as put by Mahendra Luniya, Digital Gold Expert, Chairman, Vighnaharta Gold.

(In INR)

For this calculation,  a specific tranche of  SGB has been taken to compare with the prices of physical gold. The tranche considered here is T-42 which was issued on 11 August 2020. This was one of the best tranches to buy in 2020 because the face value for this tranche has been higher than that of the average tranches. We have assumed that an informed investor, would have invested in this specific tranche. 

Also, for physical gold, we’ve taken the price of gold in Mumbai around the same time periods. 

Additionally in respect of the Interest income on SGB: The expert considered the entire 2.5 per cent for year4 in calculations assuming that remaining half of the interest accrued for the year and will be paid in less than a month’s time.

 There has been a significant difference in gold prices on the stock exchanges for SGBs v/s the actual physical prices of gold.The difference in current price for both the options is drastically different due to a demand supply mismatch on the stock exchanges due to limited supply. This additional 10% return earned for SGBs can be excluded conservatively, assuming that prices would fall back to represent actual market values.

 Understanding the difference in returns: The huge difference in absolute return over 4 years is attributed to the below points: 

1. GST Cost, increasing the purchase price: Prices of Gold as a commodity are on a steady increase and holding gold earns a decent capital gain from underlying price increases. However, the effective cost of gold increases by 3% for Option-I because GST becomes a cost for the investor, reducing the income earned. 

2. Interest Income: SGBs offer an additional income of 2.5% of the face value of the unit as interest. This additional income component has earned a total of 10% return over the 4 years. Thus, from the calculation done above and covering the note the absolute returns for SGBs come to 60-10 = 50% over a 4-year period v/s the return for physical gold is limited to 33.35%. Thus, an investor should understand the SGB product and consider it as an option against traditional physical gold to earn higher returns.