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Rusal's plan for an aluminium exchange traded fund is really good – for Rusal

Tuesday, Apr 20, 2010

Last week, Rusal, the aluminium giant run by Russian oligarch Oleg Deripaska, said it may launch an aluminium exchange-traded fund (ETF) later this year. Details are expected in the second half.

ETFs are investment funds that are traded on stock exchanges. They hold assets, often commodities, and trade at about the net asset value of the investments they contain. They are a way of investing in commodities without holding the physical item yourself.

The launch of the ETF would be a very good move – for Rusal, that is. Investors may want be more circumspect.

Rusal is responsible for about 13pc of global aluminium production. Of all the commodity classes, it is the one which has a more tarnished outlook because of its fundamentals.

Inventories of the metal continue to rise over the world, with the London Metals Exchange saying on Friday that stocks at its warehouse rose by 3,150 tonnes over the week to 4.57m tonnes. This compares with copper inventories, which fell 1,025 tonnes to 509,400 tonnes. Aluminium inventories have ballooned because of the fall in demand caused by the financial crisis. Stocks of the lightweight metal in China have risen more than 45pc this year as production increased.

Also, aluminium is ubiquitous throughout the world – it is not relatively rare like copper or platinum. In fact, it is the third most abundant element in the Earth's crust.

The metal is usually produced by electrolysis of treated bauxite, which contains up to 60pc aluminium oxide.

This abundance has been reflected in the price performance through the crisis. Aluminium prices for three-month delivery have risen 91pc since their credit-crisis nadir, but three-month copper has risen by 180pc.

All of this means that Rusal's proposed ETF is a very clever idea. It will effectively remove 1m tonnes of the metal from inventories, thus supporting the aluminium price.

Investment demand has buoyed the price of many metals over the last year. Investors hold metals hoping that prices will rise, but also as a hedge against a falling dollar. Because commodities are priced in dollars, when the value of the US currency falls it makes them cheaper in other currencies. This prompts worldwide buying and lifts prices.

In the early part of last week, palladium prices spiked. Palladium, a platinum group metal, is used in the manufacture of catalytic converters for vehicles. Demand for the metal from an investment perspective has been strong after a palladium ETF was launched in the US in January. This is physically backed by purchases of the metal.

Daniel Major, a commodity strategist at RBS, calculated that the inflow of money into palladium ETFs worldwide was equivalent to 28pc of estimated palladium consumption in the first quarter of the year. The launch of the new US fund has resulted in the amount of palladium held as an investment rising 48pc over the quarter.

This is the main reason why the palladium price has risen by almost 30pc in the year to date, although there are also worries about resource nationalism in Russia. This has led some analysts to argue that there will be a lack of palladium for most of the next decade.

It was also revealed last week that investment demand for gold last year surpassed jewellery buying for the first time since the precious metal's inflation-adjusted high in 1980. Demand almost doubled over the year, with high prices and the global economic downturn causing demand for gold jewellery to slide 20pc, according to metals consultancy GFMS.

This month, the gold price rallied to record highs in euro (€860 an ounce) and sterling (?754 an ounce), according to ETF Securities. The ETF provider said that “investors appear to be increasingly looking to gold to hedge not just against US dollar weakness, but sovereign risks more broadly”. This is an important factor when investing in metals.

Aluminium is different from gold, platinum, palladium and silver. Aluminium is not a precious metal – it is an industrial metal. Its lightweight nature means it is used in the manufacture of aircraft, machinery and many other items.

However, the case for gold is a macroeconomic one. Gold bugs consider the metal as a currency, arguing that fiat currencies that have been created after the gold standard was abandoned are ultimately doomed.

They argued that the world's major currencies will ultimately devalue against precious metals like gold and silver, the currencies of old. Aluminium is not a currency. It is not rare. It is a very useful metal whose price is affected by supply and demand.

The main benefit of the ETF is that it will remove excess inventories. As an investor, that's not a good enough reason to buy.

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