What is a commodity
Much of what happens in the world of metals is related to the commodities markets. In talking about this market its important to get some definitions in place if we want to do a rigorous analysis.
What is a commodity?
The word "commodity" is used in a number of different contexts with a few different meanings.
Looking at a dictionary definition we will see something like the following:
- an article of trade or commerce, especially a product as distinguished from a service.
- something of use, advantage, or value.
- Stock Exchange. any unprocessed or partially processed good, as grain, fruits, and vegetables, or precious metals.
- Obsolete. a quantity of goods.
In all senses of the word in current use a commodity is always a product and is never a service.
One meaning is referring to a class of economic goods, which are products of agriculture and mining, these are raw materials that end up being used in the rest of economy. In the world of finance this is usually what people are referring to when they refer to a commodity, barring some other specific context where the word has a different meaning.
Commodities are always fungible
Commodities are by definition fungible.
Fungible means that a commodity is capable of being exchanged or interchanged without it impacting the value of the item being exchanged.
If I'm running a factory and I need to buy copper in bulk I don't care if I get a kilogram of copper from one supplier or another, as long as it's pure copper it is completely interchangeable for my needs.
This however is in stark contrast to a lot of other things that might be happening at such a factory. Skilled workers are often a great example of non-fungibility at work. Say you need a skilled metallurgist for some metal based products you are making, you can't just get anyone to do this job, the person doing it likely has specialized knowledge not only of their field but also has experience the knowledge of the specific business as well. This makes such skills not fungible.
Ease of exchange isn't the only thing that makes a commodity a commodity. Something like Bitcoin is relatively easy to exchange but yet is not a commodity in the same way as say gold. Because the history of every coin and every transaction ever made on the Bitcoin network is by design stored in a public ledger that is accessible to everyone the history of transactions of each coin could impact the values of those coins. This is different to say a copper commodity contract, if copper has move around it really doesn't impact the value of what you can do with it. There's no history for each industrial bar of copper since they can be melted down and cast into other products.
How are commodities used in industry
Many people think of commodities only in terms of things people would consume in their day to day life. For a food commodity like rice or orange juice this mental model is somewhat accurate. For a more specialized commodity like palladium this mental model is less accurate, while there is a bit of palladium jewelry out there most of that metal is used in industrial processes that most people don't even know exist.
- Used in end products
- Part of a process
- Used in the production of other things
Part of what makes supply chains difficult for modern manufacturing is just how specialized some of the items are that are used in the process of manufacturing things. For example if you want to make modern electronics you need a number of tools to enable you to do this. Some of these tools like lithography tools are highly specialized and are made by only a small number of companies. In some industrial settings you will find highly specialized parts and highly specialized materials. If using some expensive tools allows a lot of value to be unlocked by a manufacturing process the economics very quickly makes it worth buying those expensive materials. The return on investment on things that will improve industrial processes can be very large.
An essential aspect of what makes a commodity a commodity is fungibility. A working definition I have for industrial commodities is that you could substitute one truckload of a commodity for another truckload from another source and it wouldn't impact your manufacturing supply chain in an engineering sense. The idea with a commodity is that they must be interchangeable. Now this is not to say that every truckload of a commodity is equally priced, for example there's many ways to make something that could be used as a feedstock for petrochemical processes using oil, but one producer might be able to provide it far cheaper than another for a number of reasons. For example it might be cheaper to mine materials in one location, but it might be less costly overall to mine materials in another more expensive location if the costs of transport are significantly lower. For some commodities like the platinum group metals the density is so high that transportation costs tend to not be a driving factor. Transporting materials takes energy and therefore energy costs have an enormous impact of all of the commodities markets. The market for Oil is so important because one of the important aspects of oil is the high potential energy that is contained in hydrocarbons. Effectively Oil is a form of relatively easily transportable energy and therefore it has a particularly large impact on the markets relative to other commodities. If you look closely you'll see that at moment oil is integral to the process of creating most commodities in the current world market.
One example of where this is of particular importance to industrial users is in feedstock materials. A huge amount of modern industry, and the modern world, relies directly upon metal fabrication and plastics fabrication. In the case of metals fabrication various raw ores have to be first mined and then processed into useable forms. In the case of plastics there's a variety of grades of oil that are required as a feedstock to create plastics products.
This post is part 5 of the "Metals" series: