Last Updated on August 22, 2022 at 11:17 pm
Have you ever wonder what returns one could get by buying Sovereign Gold Bonds? Here are some hard numbers.
Gold is an incredibly volatile asset, in fact, more volatile than stocks from time to time and investors who do not understand what they are doing could get hurt badly. No one can predict returns from gold. In fact, if you have purchased these bonds for returns, then you need to be aware returns are purely based on timing luck (when you buy).
There are at least three distinct ways in which investors approach gold. The majority of them (at least in India) accumulate it in physical form, typical jewels. Although some see it as an investment, it is a recyclable consumable.
The second approach is to “get some returns from it” by tracking the price of gold via gold ETFs, gold funds, sovereign gold bonds or other means of “e-gold”. The only to do this to be able to buy and sell the gold product freely. This cannot be done with Sov gold bonds!
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Those who want to chase after returns must employ an entry-exit plan such as this – Is this a good time to buy gold? A tactical buying strategy for gold and use ETFs for small sums and gold funds for larger amounts.
The third approach is to exploit the volatility of gold, add it to a portfolio of stocks and bonds, meticulously rebalance and track the volatility as the portfolio level. That is as a means of diversification and possible risk reduction. Needless to say, this is the hardest way to use gold.
Sovereign gold bonds offer a tax-free, risk-free way to accumulate gold as long as your future gold purchase is more than eight years away*. You also get 2.5% interest (taxable as per slab) on the initial gold value as a “thank you for reducing gold imports(temporarily)” gift from the govt.
This is risk-free because the bond tracks the price of 24-carat gold and at any given time and after eight years one could buy 22-carat jewellery. * These bonds cannot be sold in the middle of the tenure unless you are willing to take a loss. So if you want to buy jewels after 10 years, buy the bonds for the first eight years and then hold cash or buy the gold asap.
The second approach noted above will end up cluttering the portfolio and is best avoided. Those who are serious about diversification with gold can use a gold fund that invests in a gold ETF. Although a bit more expensive than an ETF, it is easy to transact.
Regardless of the amount invested or withdrawn, the gold fund will have to honour the transaction. Of course, the underlying gold ETF should be liquid, with frequent trading and low NAV-price variations.
When the ultimate aim is to buy gold, returns from gold bonds or any other instrument are irrelevant. When the aim is diversification, then returns from gold should not be a major concern. Thankfully so because gold is volatile that one simply cannot expect 6%, 8%, comparable to inflation or any other number. The variation in returns is simply too great!
Let us look at the Gold USD and Gold INR per troy ounce (31.1 grams) daily data from Jan 1979 and study every possible return over 5,8,10,15,20 and 25 year periods.
Notice how after our economy opened up in the 90s, Gold INR kept moving up only because of the exchange rate. Both Gold prices are better correlated in the two decades.
Now let us look at the rolling returns gallery. Please pay attention to the “spread” in possible returns for a given duration. The number of data points is indicated within each plot.
Notice that it is simply impossible to say or expect gold would X or Y returns. The spread is just too much. Something or the other has occurred in the past. In the period studied: US recession of the late 70s, Indian economy opening up, the dot com crisis, housing crisis, trade wars. etc. All we can say is the future should be just as colourful!
Do not buy Sovereign Gold Bond for returns! What you “get” will depend on luck!
Also, there is little correlation with inflation. Shown below is the ten-year return of Gold USD and 10-year change in the consumer price index in the US.
If we cannot expect returns, what is the way out? Fortunately, it is not necessary to expect a return. Those with jewels as an end-use can simply track the price with gold bonds. Those who wish to diversify their portfolios with gold must first consider how much to include and how beneficial it would be: Will including gold in my portfolio help?
One could argue that gold is not necessary for a long-term portfolio and effective management is possible with stocks and bonds. Also see: How much gold in my portfolio will protect against a market crash?
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