If you overlaid a daily chart of the cash LME nickel market on that of LME aluminum, you’d scarcely see a difference in nickel’s and aluminum’s price trajectories over the past year. Except for a short-lived divergence between November 2009 and March 2010, aluminum and nickel have traded in virtual lock step with one another. That’s reflected in the current 67 percent correlation between the Dow Jones-UBS Aluminum Subindex and its nickel counterpart.

Yet, despite the recent similarities between the two markets, nickel investors have handily outgunned aluminum buyers. The one-year return on the iPath Dow Jones-UBS Nickel Total Return Sub-Index ETN (NYSE: JJN) is now more than double that of the iPath Dow Jones-UBS Aluminum Total Return Sub-Index ETN (NYSE: JJU).

Cyclically, nickel’s closer to a top, while aluminum seems to be ripening for a more bullish turnaround.

A Tale Of Two Metal ETNs: JJU Vs. JJN (Closing Prices Only)

Performance Characteristics As Of 25-May-10

Fundamentals

As you might surmise from the chart, fundamentals for nickel have been more bullish to date. Most significantly, there’s a decreasing supply of nickel. In the last month alone, LME warehouse stocks have fallen 5 percent, or 7,278 metric tons.

A primary use of nickel is the manufacture of stainless steel. China’s been a leading consumer of all things nickel and is likely to compete for supplies with recovering U.S. industrial demand.

Aluminum stockpiles, in contrast, have been rising recently. LME stocks have climbed 15,750 metric tons, or 0.3 percent. Over the past year, stores have seesawed from the 4.2 million-ton level to 4.6 million tons.

China figures into the aluminum equation as well, but more as a source. The People’s Republic is the world’s largest producer.

So, for both metals, China’s the wild card.

And, for any U.S. investor considering a direct investment—short or long—in nickel or aluminum, careful consideration should be paid to the exchange-traded notes tracking the metals’ performance.

ETN Characteristics

The table under the price chart recaps some comparative statistics for the iPath nickel and aluminum ETNs. The one-year return is, of course, self-explanatory, but the other metrics might need explication.

Annualized Volatility: This risk measure is derived as the standard deviation of the ETNs’ daily returns. It’s based upon the ETNs’ last sale price of the day. The higher the percentage, the more volatile the ETN price—meaning the greater the day-to-day variance.

For JJU, the aluminum ETN, prices spiked as much as 8.5 percent from one day to the next and slumped as much as 15.7 percent. The more volatile JJN nickel note’s day-to-day variances ranged from 15.9 percent to -12.7 percent.

When standard deviation is used as a measure of risk, upside volatility is treated the same as downside volatility, even though most investors—at least long investors—would welcome more upside variance.

Clearly, there’s more downside volatility with the aluminum product despite its lower standard deviation.

Recent Spread: The spread between an ETN’s bid and offer reflects its immediate liquidity and varies for a number of reasons. One determinant is the liquidity of the underlying market. If swaps, futures or other proxies for metal exposure are more readily available, note spreads tend to be tighter. Inventory levels held by market makers, as well as institutional accounts, also influence the spread’s width.

Daily Volume: This metric is simply the average daily turnover over the previous three months.

Tracking Error: Tracking error reflects the variance between an ETN’s end-of-day indicative value and its underlying index. Indicative values are computed and broadcast every 15 seconds throughout the trading day, reflecting the current redemption value of the note.

Here, tracking error represents the median daily variance going back to July 2008. While there appears to be no variance, in actuality, indicative values for JJN swung between a 26 basis point (0.26 percent) premium to a 25 basis point (0.25 percent) discount to the Dow Jones-UBS Nickel Subindex Total Return. The daily tracking error for the JJU note ranged from a 6 basis point premium to a 10 basis point discount.

Premium/Discount: The median difference between an ETN’s closing, or last sale, price and its terminal indicative value is reflected in the premium/discount metric. Variances here are often, but not always, driven by timing artifacts. Sometimes there can be significant time lapses between the last trade and the day’s final indicative value broadcast, so such premiums and discounts tend to be exaggerated compared with those computed with the midpoint of the day’s final bid/ask spread.

The JJU note’s apparent 8 basis point premium belies the actual daily variance which ran between a 6.39 percent premium and a 17.48 percent discount. The range for the JJN note was topped at a 7.33 percent premium and dipped to a 9.18 percent discount.

Summing Up

It remains to be seen how nickel and aluminum will jockey their positions, but when and if they do, investors should now know a bit more about the investment dynamics of the note markets.

Written by Brad Zigler From Hard Assets Investor

HardAssetsInvestor.com (HAI) is a research-oriented Web site devoted to sharing ideas about hard assets investing. The site has been developed as an educational resource for both individual and institutional investors interested in learning more about commodity equities, commodity futures and gold (the three major components of the hard assets marketplace). The site will focus on hard assets investing without endorsing or recommending any particular investment product or approach.

Related posts:

1. Investing In A Pure Play Nickel Exchange Traded Product With This Nickel ETN
2. Aluminum To $3000: Physically Backed Aluminum ETF May Soon Become Reality
3. So How ‘Bout That Aluminum ETF? (JJU, AA, RTP, ACH)
4. Global X Unveils More Details For Their Proposed Aluminum ETF
5. Callable iPath Notes Chart A New Course (GAZ, JJN, DBA)

JJN, JJU