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Sovereign Gold Bonds, Secondary Market And Free Money



It can’t be right. I am definitely missing something. I get it market - does misprice traded securities sometimes but it is rare such mispricing continues for extended period, especially for securities where one is bound to get assured price (not returns) with a publicly available agreed benchmark.

I am talking about SGB’s – the Indian government gold price denominated security which is benchmarked to 999 purity gold price. How does RBI, the Indian central bank price these bonds? Fact is, it doesn’t. It lets the market (aka IBJA Rates – IBJARATES.COM) determine the price – at which it issues and also the price at which it redeems these gold denominated bonds – during final maturity after 8 years of issuance or even during premature redemption option after 5 years.

Meanwhile, from issuance period till final redemption, these bonds trade in stock exchanges – like other securities, mostly at discount to spot rates. Let me go with an example: – I own Aug 2028 Series V SGB. Let’ see the discount:

-          Closing price of captioned SGB as on 23 Feb 2023, on volume weighted average basis: INR 5271.97/-

-          3 day average closing price of 999 purity gold as sourced from IBJRATES.COM – INR 5649.37/-

-          Discount at which this SGB is available from secondary market: 6.68%. That's very much the assured benefit being available to somebody who can ride out the holding period till maturity

Still don’t get it. Let’s do some more numbers, with just couple of assumptions thrown in. Here we go:

-          Say you buy Aug 2028 Series V SGB from stock exchange and hold till maturity. That’s good 5.5 years from now. Your buy price per gram – 5300/-

-          IBJA rates price of gold per gram – say 7% above SGB price, which comes to INR 5671/-

-          Say the gold rates, basis IBJA Rates go up by 5% every year. At the end of 5.5 years, gold would be quoting at INR 7416.53/- per gram as per IBJA rates. This is more or less the price you will get for your SGBs

-          Your ROI: 6.30%. Effectively, you get 1.30% extra ROI per annum due to pricing discount of secondary market SGBs. I would call this free money on the table

-          To put it in absolute terms, if you buy INR 10 Lacs worth of captioned SGBs today, at maturity, you will get nearly INR 91000/- as “free money” due to secondary market mispricing. Good sum I would say

That’s the reason I have been buying SGBs from secondary market. But why the mispricing? Sort of lack of liquidity discount. My guess is most of the SGB buyers are “hold till maturity” types and there is no market maker as such. Result – poor liquidity. The market is treating such bonds as sort of closed ended fund and hence trading at discount to NAV (AKA spot gold price). That said, I have never faced any issue in buying small quantities of SGBs from stock exchange. Off course – at discount to spot prices.

For those having staying power, moneywise and will wise, this is as good as getting some free money.

But hey remember – don’t take this as investment advise. It is not. Just sharing my thoughts!!!

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