Aluminum ETF: Due For A Crash?

by on November 24, 2009 | ETFs Mentioned:

U.S. stocks and aluminum represent very different asset classes, but some investors have begun to notice troublesome similarities between the two. Following a furious bull market rally on Wall Street over the last several months, it is beginning to appear that U.S. stocks have run too far too fast. By many measures, domestic equity markets are now overvalued, perhaps by as much as 25%.

AluminumA similar situation is unfolding in aluminum markets. Hopes for an uptick in global manufacturing activity have sent prices for the metal higher, but supplies continue to increase as well, leading many investors to believe that we will see a sharp downward correction in coming months. “I don’t see why the aluminum price has gotten so high,” said Peter Sorrentino, a fund manager at Huntington Asset Advisors in Cincinnati. “There’s plenty of supply around and demand is still quiet. There’s a disconnect between the price and reality.”

Barclays Capital is projecting that the global surplus of aluminum will increase 29% next year to 1.63 metric tonnes as the largest price increase in recent memory encourages producers to up output. Aluminum prices have gained more than 30% this year, despite the fact that an increase in demand is yet to materialize. Prices for the metal, which recently closed at approximately $1,980 per tonne, will average about $1,885 per tonne next year on the London Metal Exchange according to a Bloomberg survey, indicating that a downward correction is anticipated. Despite this expectation, aluminum futures market is in a state of contango, with 27 month futures trading almost 12% above spot settlement rates.

Aluminum Futures Are In Contango

Supply And Demand

Aluminum’s malleable and corrosion-resistant properties make it useful in a variety of applications. But many of the most aluminum-intensive products, including automobiles, aircraft, and new home components, have seen sharp downturns in demand in recent years, which in turn has reduced the need for aluminum.

China, responsible for an increasing portion of global aluminum use as its economy races ahead, will also seen its aluminum production rise by almost 20% next year, offsetting increased demand for raw materials as the manufacturing sector expands.

Several other sources are expected to contribute to increases in aluminum supplies in coming years. The world’s biggest smelter, run by Emirates Aluminum, is expected to come online in April. The project covers more than two square miles in Abu Dhabi and will eventually produce 1.4 million tonnes annually. The Qatalum project, a venture between Hydro and Qatar Petroleum, will also make significant contributions to global supplies when production begins.

Aluminum ETF Options

While the downward pressure on aluminum prices appears to be mounting, there are reasons to be bullish on the metal’s price as well. Prices remain well below the record high of nearly $3,400 per tonne hit in July 2008, and a return to health of the U.S. manufacturing sector, particularly the automobile industry, could give aluminum prices a boost.

Ticker ETF Aluminum %
DBB PowerShares DB Base Metals Fund 33.5%
JJM iPath DJ-UBS Industrial Metals ETN 26.1%
UBM UBS E-TRACS CMCI Industrial Metals Total Return 33.2%

There are a number of ways for investors to gain exposure to aluminum prices through ETFs, including several diversified industrial metals funds that invest in various futures contracts.

In addition to these broad products, the iPath DJ-UBS Aluminum Total Return Sub-Index ETN (JJU) is linked to a benchmark composed entirely of an aluminum future contract. As an exchange-traded note, JJU is essentially a senior secured debt instrument, and as such comes with some degree of credit risk (although Barclays has a solid credit rating). JJU has gained about 20% so far in 2009 and charges an expense ratio of 0.75%.


Disclosure: No positions at time of writing.