Commodities derive a significant part of their value from network effects. For example, the value of oil is, at least in part, derived from the transportation and refining network that serves it (the pipelines, tankers, refineries and so on), which in turn enables end consumers to derive value from it. Oil, and for that matter coal or natural gas can be burnt outside of this network, but without access to it the value of the fossil fuels are compromised – the range of applications and the market for which they can serve are severely diminished.
The same argument can be made for other commodities too. Even gold has a network effect. Without golds role in jewellery, without the existence of bank vaults in which to store gold securely, and without a community of investors willing to hold gold rather than productive assets, its hard to argue that the value of gold would be not be diminished. Gold would still be there of course, lying in-situ even if none of these factors were in place, but that doesn’t mean it would hold as much value simply by being.
Threats to a commodity network can be profoundly disorientating for physical and financial actors who are invested in the networks value being maintained. This is why the decarbonization energy transition (exemplified by the growth in renewables and electric vehicles) are seen as such a threat to the fossil fuel network, and bitcoin is seen as a threat to holders of gold. For example, climate campaigners erroneously attack new oil pipeline projects on environmental grounds (see the disputed Keystone XL pipeline), but what they are really doing is attacking the network value of oil.
Instead of admitting that the challenger is a threat to the incumbents network, the assault is dismissed as being not worthy by those invested in the incumbent. This is the point at which tribalism begins to rear its head. Everyone has their own pet rock – crude oil, natural gas, coal, tin, lithium, gold, silver, or something else. Each commodity has their own community of investors and ideological supporters for which there is no alternative, for which few understand, and for which you must have fun being poor if you are invested in anything else.
We reach a point that I call commodity maximalism where being fully invested in your pet rock (or its producers) is seen as being the only way forward. If only we could build a movement that enhanced the network effects of our favoured pet rock then it would be able to beat off any adversaries. Unfortunately individual investors (or their communities) do not have that power.
The job of commodity investors is to single-mindedly pursue the best risk adjusted returns at this point in the commodity cycle. An investment strategy of commodity maximalism is one built on hope and ideology, it is not built on the cold-hearted pursuit of the best fundamental investments.
Related article: The catalyst
Check out my online course on Skillshare. Everything you need to know about commodities in less than 60 minutes (link gives you 2 months free) Join - Skillshare
Materials Risk also provides in-depth training on commodity markets for both investors and supply chain specialists.