Aluminum, Steel and the Difference Between Miners and Manufacturers(1)

A lot of people have talked about investing in commodities as a hedge against inflation. Commodities in the strictest sense are basic building blocks that are needed to make other products (or to eat raw, etc.). Today I am specifically talking about metals and metal ores. Gold, silver, copper, iron ore, platinum, and others are basic commodities. When you invest in a stock as a play on gold, it is usually a gold mining stock. However, the concept becomes a little blurred when you talk about steel and aluminum. Some people view these metals as commodities. Aluminum even traded until recently on the COMEX, when it was delisted. The London Metals Exchange now carries quotes for it.

Strictly speaking, Bauxite ore is the commodity for aluminum. For steel, iron ore is the major commodity. Why is this important? It is important because there is a layer of manufacturing between the commodity and the finished product for steel and aluminum. For example, wheat is a commodity, but wheat bread is not. Wheat bread is manufactured from wheat. Wheat bread is not as good a play on wheat as the commodity itself. If you are hedging against inflation or famine with wheat, wheat is a much better, much more direct instrument than wheat bread. The same is true for metals. Iron ore is the real commodity. It is the direct play on steel (unless there is a big coal or chromium shortage).

Bauxite is the direct play on aluminum. Why is this important? It is important because many emerging economies are trying to manufacture things more cheaply than the more developed countries. This is a familiar pattern. An emerging economy will try to take business away from a developed country by providing cheaper labor, which translates into cheaper manufactured products. Textiles are often a prime first target. However, relatively simple but labor intensive manufacturing of metals such as steel and aluminum are another area of targeted competition.

In the 1960’s and 1970’s Japan took business away from the US steel industry. Later the Koreans became a bigger force. Both of the aforementioned countries soon expanded to autos, and electronics. China is doing the same thing now. One difference is that it already makes over 50% of the worldwide steel. It is the top dog. It can bully the other players. It also like most businesses wants to dominate its market.

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