The Myth of “Commodities”

We’re currently in substantial economic doldrums to some extent because the Chinese are buying or more accurately indicating their future demand for many commodities.

It matters a lot because China’s been consuming 30-40% of each of the world’s categories of commodities  for over a decade between building 150 cities with over a million residents, that infrastructure, a deep sea Navy including aircraft carriers, adding 200 million automobiles and trucks in recent years, and their vast expansion of manufacturing facilities.   So that’s a vast amount of steel/iron ore/chromium/vanadium/manganese/cobalt/nickel/molybdenum/tungsten, copper, tin, zinc, aluminum/bauxite, coal, coke, clays, hardwoods, softwoods, cotton, flax, wool, cow leather, gold, platinum, palladium, mica, rhodium, iridium, rare earth minerals, silver, industrial diamonds, glass, rubber, oil, petroleum products: polyethylene, polypropolene, polyphenolic resins, butlyl (tires), polyesters, propane, butane, jet fuel, aviation gasoline, lubricating oils, asphalt, petroleum coke, adhesives, isopropyl alcohol, paint, solvents, sealants, etc.

The rest of the developing world uses and produces a lot of commodities as do the most advanced economies (most people think everything comes from the roughest places on Earth, and to an extent that’s become even more true because of land costs, access, permitting, and the impacts on immediate neighbors so vast amounts of commodities are now underneath populous areas or no longer accessible thanks to laws, regulations, and current public policy.

A commodity is defined by economists (people who don’t get out much and oversimplify everything)  as stuff that is functionally or essentially identical so you might as well pay as little as you can for it, based mostly on competing bidders for the commodity at that very moment and place.

Physical reality as usual trumps economic theory, which is where people who make and use commodities diverge considerably from economists, commodities traders, financial journalists, and government policy makers.  

Where a commodity is turns out to be hugely significant, a mile from where you need it or deep in mountainous jungles full of murderous drug gangs on the opposite end of the Earth.   Commodities far from international transportation, usually a ship, sometimes a railroad network connection, a heavy truck with decent roads, or sometimes an airport, are often valueless or at a steep discount (even oil produced a few hundred or a thousand miles from an oil refinery is often worth 40% less than the international commodity price per barrel because there isn’t an existing oil pipeline to get it to the refinery cheaply enough.)   For a classic commodity like coal (if they don’t stipulate the coal’s heat yield which varies by mine’s deposits, type, impurities, processing, etc. it tells you they’re pretending coal is a simple commodity) the rail or ship transportation to get it where it’s needed is most of the cost, 70% is typical and coal that’s just too costly to reach you is most of the world’s coal, making international commodity prices more of a very rough guideline for some situations at best.

When it’s available turns out to matter a lot, like bananas that will ripen and then rot before they can be harvested and shipped to banana eaters in Europe, cut flower with a few days in Colombia before they have any value in Miami, cattle slaughtered early that are high value veal and slaughtered late that are only fit for hamburgers smothered in concealing condiments.   Wartime is the ultimate driver of “when” in commodity values, as are boomtowns, bustvilles, economic depressions, high inflation, disaster zones, droughts, taxation schemes, etc.

Why it’s available is often a key determinant in price, but still constrained mightily by how will you get it to me when I need it?   A savvy commodities buyer (not to be confused with a commodities speculator who’s surprisingly little informed about the commodity and just likes the gambling/easy money aspect, even though ultimately most commodities speculators lose their capital like most gamblers) is always hoping for a desperate seller with too much, too wrong, too stranded in the wrong place, too urgent of a big loan to be repaid or a payroll to be met, too disappointed at the usual customers’ lack of interest or ability to buy, or undercut by a new or old competitor.  That desperation and lack of negotiating power is the underlying assumption in commodities while a vague optimism of plenty of profitable customers is the underlying assumption in the costly, complex, and time-consuming process of producing commodities.   Speculators and traders consider themselves the smartest part of the process, however when you talk at length with the producers and the users, the middlemen reveal themselves to be the least knowledgable and least interested in the commodity.

How Much to pay/sell the commodity for is also far messier than it appears.   More often than not the price depends on borrowed money (on all sides of the transaction, all of it short-term loans by grumpy or unaware lenders so there’s a lot of pressure on all sides to repay.)  Figuring that aspect out is how a fruit and vegetable wholesale warehouse’s bookkeeper put together the largest personal fortune of the 20th Century, John D. Rockefeller of Standard Oil.   Nobody has all of the information they want or need at the moment, and much of it is more wishful thinking, dumb opinions, baseless rumors, misinterpreted data, and false price signals as part of everyone’s bluffing and maneuvering for momentary advantage.   So it is far more like a poker game with known cheats than taking the posted figure of the moment as the price. 

Futures trading on commodities, buying them for delivery months or years from now instead of immediately so ore that hasn’t yet been mined, crops not yet planted, hogs not yet born, etc. and guessing what the local and overall market will be like then (booming, sinking, stagnating?)  only gets more popular and messier, especially with electronic trading that means many of the commodities “buyers” never take physical possession/use what they’ve bought but instead sell it to a series of like-minded speculators before someone who’ll actually use it buys it.  That makes up as much as 35% of the price of a barrel of oil these days and trivial to major percentages of many other commodities.

Commodities are actually quite different if you know 19th Century science or better.   When you’re actually going to use the stuff, you pay a lot more attention to it as subtle variations in quality, performance, reliability, etc. will make or break your product whether it’s a fancy meal ruined by a tough flavorless steak or steel lacking the right proportion of alloying elements like nickel or vanadium to keep an artillery barrel from bursting in combat.    No matter what it is, it’s source, how it’s handled or processed, how it’s packaged, how it’s shipped, moisture content, temperatures, chemical reactions, etc. makes a great deal of difference, except to economists which is like saying all women are alike so marrying anyone has the same outcome.   A common example is a beefsteak.   The breed of cow, say Black Angus bred for meat flavor vs. an Ayrshire bred for milk production, makes a big difference so Ruth Chris steakhouses use Black Angus and McDonalds uses old milk cows mostly.  How the cow is fed and exercised in it’s 3-5 years of life changes the muscle and fat ratios-more fat more flavor and tenderness while more lean muscle from eating just grass makes it more desirable to many diners afraid of fat.   If it’s killed with minimal stress, it doesn’t accumulate stress hormones that damage the meat flavor.   If it’s in a controlled rot for 3 weeks at low but not freezing temperatures, the enzymes break down the muscle tissue into the tenderness of a $35-60 steak dinner rather than the more common 2 days to a week that make it a supermarket steak for $8.99.   Even dirt, sand, air, water, clay, mud, electricity, natural gas, gasoline, wheat, barley, alcohol, sugar, cooking oils, dimensional pine lumber, nails, screws, etc. aren’t truly interchangeable commodities with no significant differences.

Unless you’re an economist.

 

Al Jones has slowwwwly learned the significant differences of many commodities in working with many producers, users, processors, etc. in 40+ industries and thousands of firms.   They’re actually fascinating, just like economic theory is not (read too much of that too, about as useful as watching horror movies to plan a safe life.)    He can be reached at aljonesrdo@bresnan.net

 

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