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Home / Money / Personal Finance /  The hidden benefit of buying sovereign gold bonds in the secondary market

India’s love for gold knows no bounds. While physical gold has an emotional value to it, paper form of gold works best for those seeking investment value in it. In fact, in the ongoing wedding season, why not gift sovereign gold bonds (SGBs) over gold jewellery or coins?

Moreover, you can start investing in gold bonds for your children’s wedding, converting it into physical gold when the time comes. Parents start storing physical gold from the moment a child is born—be it a girl or a boy. Prefer gold bonds over it. Not only do gold bonds trade at a discount to the physical gold, you can buy it in tranches, making it affordable for you to stretch over a time period. Moreover, you don’t have to pay extra on the making charges. There will not be any goods and services tax.

Another major benefit with SGBs is tax-free capital gains if you hold it till maturity. SGBs mature after eight years and come with a lock-in period of five years. If you want flexibility with the maturity period and avoid lock-in, you can buy SGBs from the secondary market too.

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SGBs are the government-backed security that the Reserve Bank of India (RBI) issues multiple times in a year. Investors also earn an interest amount of 2.5% per annum paid bi-annually on their initial investment.

The primary issuance of SGBs—Series VIII for the financial year 2021-22—has kicked off today. The issue price has been fixed at 4,791 per gram with 50 discount if you buy it digitally. One gram makes for one unit of gold bonds. Compare it with the physical gold prices, which quoted at 4,972 per gram in Ahmedabad on Friday.

While subscribing to the primary issuance has its benefits, most SGB series in the secondary market are available at much better prices compared to the ongoing series and the prevailing gold prices. Should you buy one of them? You will find out soon.

Gold bonds in the secondary market

Since each SGB series gets listed on the stock exchanges, one can buy units from the BSE and NSE if one holds a demat account. As many as 56 series of SGBs are trading in the cash segment of the BSE and NSE. The buying prices of all the series (as on Friday closing) are below the issue price of the fresh series. This is typically a result of sellers willing to accept a discount in return for a quick exit from the instrument.

So, should you buy the series with the lowest price? Not necessarily. You need to check their liquidity, respective issue prices and the interest component.

The liquidity factor

First and foremost, you must know that liquidity plays a major role in the secondary market. You cannot buy just any series. It has to be liquid enough to meet your demand. “If we look at the top traded issues, the average daily volume is around 5,000 grams," says Sugandha Sachdeva, VP - currency & commodity research, Religare Broking.

We have compiled a list of the top 10 series with the highest liquidity as per their one-month average trading volume data (see graphic).

Understand interest dynamics

SGBs give you 2.5% interest per annum paid twice a year. The interest is payable on the issue price of a particular series, not on your buying price in the secondary market. So, when you are buying a series in the secondary market, do not just go for the lowest trading price. Look at the issue prices also. Your purchase price should be lower than the issue price.

“The criteria to select from the available tranches of gold bonds in the secondary market should be to look for a liquid series and likely at a discount over the issue price. It is convenient to purchase the top traded series and redemption would also be much easier, without much volume constraint," says Sachdeva.

For example, the buying price of the most liquid series, SGBAUG28V, at 4,775 is at a discount to its issue price of 5,334 per unit. Compare it with the fresh series that started today. The SGBAUG28V series not only is offering you a lower buying price per unit, but also the higher interest component. The series will mature a year earlier also. Similarly, SGBMAY29I and SGBJUL28IV also look attractive.

SGBMAY28 may not be a good choice as the issue price here is lower than its buying price. While you will be getting the units at much lower prices ( 4,689.99 per unit) compared to the fresh issue at 4,791, the 2.5% interest on your investment amount will be much lower than what you would otherwise get if you subscribe to the fresh issue. “Buying in the secondary market can boost the overall return by offering a discounted price to the fresh issue, as well as a higher yield," says Sachdeva.

The taxation

Buying in the secondary market also gives you tax advantage. The capital gains tax in SGBs is nil if you sell it on maturity, that is, after eight years. This is applicable even if you buy it in the secondary market for the residual maturity.

“The Income Tax Act clearly says if you are redeeming gold bonds at maturity, the capital gains will remain tax-free. So, one can interpret that the buyer in the secondary market will get the tax-free treatment at redemption because the seller has already paid taxes to the government for the time period during which he or she held it," says Sujit Bangar, founder, Taxbuddy.com.

To simplify, if you buy units of a series in the secondary market, which will be maturing after two years, your capital gains on maturity will still be tax-free. In case of physical gold, you have to pay short-term capital gains (STCG) tax as per your income tax slab rate, while long-term capital gains tax is levied at 20% with indexation. SGBs in the secondary market are less explored but offer great value if one buys a liquid series with a trading price lower than its own issue price and that of the fresh issue.

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