LONDON, June 29 （Reuters） - Cheaper, easier and safer than derivative contracts is the verdict for aluminium exchange traded funds （ETFs）, which would not be possible without an abundance of metal on the world market.
These physically-backed ETFs could also pose a threat to commodity indices such as that offered by Standard & Poor's GSCI, which have dominated institutional investor business for many years now.
"They are ideal for investors who don't have sophisticated knowledge of metals, of futures contracts and their behaviour," said Ian Morley, chairman of Wentworth Hall consultancy.
"Someone else takes care of the details, ETFs give investors exposure in a liquid tradable format without the risk of margin calls or having to worry about things like contango." Futures are typically bought or sold on margin. That is, the investor deposits a fraction of the value of the contracts purchased with the broker as collateral.
If the position moves against the investor, the broker makes a margin call -- effectively more collateral.
The contango is the price discount for a nearby contract against one with a longer maturity. It is one reason why the S&P GSCI total return index, which is based on futures contracts and rolls forward contracts, lost more than 45 percent in 2008 and is down more than 10 percent so far this year.
The contango between the aluminium cash contract and the three-month future on the London Metal Exchange has mostly ranged between $30 and $60 a tonne over the past couple of years.
"If as a commodity investor you previously used indices, you paid the contango. If you use ETFs you get the physical stuff and you don't have any counterparty risk," said Eugen Weinberg, commodities analyst at Commerzbank.
Counterparty or credit risk would normally only be a problem for over the counter deals, not for exchange-traded contracts cleared by companies such as LCH.Clearnet, as was the case after the collapse of Lehman Brothers in September 2008.
KEY QUESTION
But a key question is how can ETFs make sense in an oversupplied market and expected to see a large surplus, possibly up to 1 million tonnes, this year?
"ETFs makes sense for aluminium as there are huge stocks, so it makes sense for producers to take some of that material out of the market," Weinberg said.
Inventories of aluminium in London Metal Exchange warehouses stand at around 4.44 million tonnes -- about 12 percent of global production -- compared with a record above 4.64 million tonnes seen in January.
A physically-backed copper ETF would be difficult as LME stocks at around 453,000 tonnes are about 2 percent of global production estimated at 19 million tonnes this year.
Someone trying to launch a copper ETF would come across strong oppositions from consumers, much like the situation with autocatalyst material platinum in previous years.
SHORT SELL
The world's top aluminium producer, Russia's UC RUSAL said in April that it was considering launching a physically-backed ETF, with details being finalised in the second half of this year.
The market is also talking about the potential launch of a physically-backed aluminium ETF by the world's biggest commodity trader Glencore International and Swiss-based investment bank Credit Suisse.
"People can take a directional long or short view with ETFs," said Ashok Shah, chief investment officer at fund firm London & Capital. "It's a different way of pricing aluminium and will involve a different group of players."
ETFs are listed, so investors wanting to bet on lower prices can borrow and sell -- known as a short position.
They are also useful for those who are looking for short-term exposure without the use of commodity indices.
"If you think China is going to shut down capacity and prices are going to rise then you can buy the ETF," a London-based fund manager said. "The next question is where would an aluminium ETF be listed -- London, New York, Tokyo?"
The world's largest producer and consumer of aluminium is China, accounting for some 35 percent of global aluminium production of 36 million tonnes last year, according to the International Aluminium Institute.
China houses some of the highest cost aluminium producers in the world and current prices at around $1,980 a tonne mean many of them are making large losses.
（Editing by Sue Thomas）
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