SINGAPORE, Apr. 23 -- The launch of physical aluminum exchange-traded fund products faces a number of practical difficulties and won't, in itself, push the aluminum market towards a supply and demand balance, JP Morgan said in a report dated Thursday.

The bank also said the apparent desire of producers to launch ETF products was a symptom of an oversupplied market rather than a response to investor interest in such a product.

"It is worth noting that it seems--especially in the case of UC Rusal--that the interest of the producer community to launch an ETF product is reflective of the surplus environment still in play, along with the record level of inventories, and as such doesn't really reflect demand from investors."

Executives of UC Rusal, the world's largest aluminum producer, have reportedly said they are considering launching an aluminum ETF, while Swiss commodity trading house Glencore International AG and Credit Suisse Group are said to be working on the details of a similar physically-backed product.

JP Morgan said the successful launch of physically backed ETFs in the precious metals space won't necessarily be repeated with aluminum, where the costs of storage would likely to be considerably higher.

This would potentially raise the management expense ratio, the cost the fund manager charges investors for the administration of the fund, beyond a level which would be attractive to investors.

The bank also said the prospect of physical redemption of aluminum backing the ETF raises a host of potential problems, with the possibility that customers may sometimes choose to withdraw metal from the ETF rather than buy metal directly from the producer and pay the normal physical premium.

"It--an ETF--could thus cannibalize their physical business, and could--as has been discovered in the precious metals arena--undermine investor appetite for equity in the company."

The bank said that what would ultimately balance the aluminium market was either long-term demand growth or smelter rationalization rather than the advent of a physically backed ETF.

Global aluminum inventories are high, with 4.57 million metric tons in London Metal Exchange warehouses and off-exchange stocks estimated around 3 million tons, which would make the total equivalent to more than one-third of entire 2009 production.

At 0335 GMT, LME three-month aluminum was trading at $2,320/ton, up $1 since Thursday's kerb.