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Is It Time to Buy Top-Ranked Aluminum ETFs?

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After nickel, it is aluminum which has been gaining massively as Indonesia enforced a ban on unprocessed mineral ore shipments, effective January 12. Initially the impact of the ban was felt less on this base metal’s prices probably thanks to higher supplies in China.

Also, bauxite (an aluminum ore) which has a huge reserve in Indonesia, makes up a small part of aluminum’s total output cost. Whatever be the case, the ban gradually started to gnaw on the aluminum inventory thus pushing the prices for the metal higher (read: 3 Commodity ETFs Beating the Market in 2014).

As per the Financial Times, Indonesia accounted for about 60% of global bauxite exports over the period of 2007 to 2013. Also, China – one of the world’s largest users of aluminum, traded in around two-thirds of its bauxite requirement from Indonesia in 2013. The demand scenario is shaping up pretty well in another Asian nation – Japan – which decided to pay a record fee for the metal amid surging demand and reduced production.

It has been around five months that Indonesia has not permitted any ore export. As result, two aluminum exchange traded products – iPath Dow Jones-UBS Aluminum Subindex Total ReturnSM ETN (JJU - Free Report) and iPath Pure Beta Aluminum ETN (FOIL - Free Report) – have advanced about 7.7% and 6.1%, respectively, in the last three months. Investors should note that the metal retreated about 13% last year so this is a welcomed reversal (read: The Real Winner from the Precious Metal ETF Rally).

In 2013, aluminum prices slipped, and in the fourth quarter, London Metal Exchange (LME) aluminum prices fell to a four-year low, given the oversupply of the metal in the market (evidenced by large aluminum inventories in LME warehouses).

Realized aluminum prices declined 8% year over year in the first quarter of 2014. Lower prices for the finished goods and higher material costs make it difficult for the producers to deliver the same output.

As per Rusal – one of the world's biggest aluminum producers-- Chinese aluminum producers are expected to cut back on production by 3.5 million tons this year in view of mounting losses. Moreover, the Chinese government is forcing unprofitable and polluting companies to shutdown facilities as part of its reform program.

On the demand side, usage of aluminum is expected to improve on a global basis bolstered by the automotive and packaging industries which comprise the key consumer market. The automobile market is also becoming increasingly aluminum-intensive, given the metal’s recyclability and light-weight properties.

The Japanese economy is expanding at a steady clip with machinery orders hovering at multi-year high levels (read: Japan ETFs: One Year After Abenomics). Evidence of stabilization in the Chinese economy should also play a role in sending the metal price north going forward.

How to Play

In terms of options for this corner of the market, only the above-mentioned products are available. Both JJU and FOIL are light in asset base, thinly traded and have wide bid/ask spreads thus causing high trading costs over and above the 0.75% of expense ratio for each.

While JJU tracks the Dow Jones-UBS Aluminum Subindex Total Return, which delivers returns through an unleveraged investment in the futures contracts on aluminum and currently consists of one futures contract on the commodity.

It trades in a paltry volume of less than 4,000 shares on average daily basis and has attracted just $3.4 million in AUM. JJU currently has a Zacks ETF Rank of 1 or Strong Buy rating with a High risk outlook.

FOIL looks to replicate the return of the Barclays Capital Aluminum Pure Beta TR Index. It reflects the returns that are potentially available through an unleveraged investment in the futures contracts in the Aluminum markets. The index may roll into one of a number of futures contracts with varying expiration dates.

The note trades in much lighter volume of 1,000 shares a day and has an asset base of $2.5 million. FOIL has also a Zacks ETF rank of 1 but with a Medium risk outlook.

Bottom Line

While commodities might lose steam once the Fed fully wraps up the QE program and the dollar gains strength, at least a few like aluminum might be able to provide some uncorrelated gains, at least in the short term (read: Precious Metal ETFs Crumble in Fed Meeting Aftermath).

Given that aluminum prices seem to be on the rise with supply/demand imbalances, both the above-mentioned products could be interesting picks for investors looking to make a concentrated play on this corner of the base metal market. The relative strength index of both the products is hovering around 56 indicating that these are yet to reach overbought territory, and that they still might be interesting picks for investors in the near term.

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