Previously, raw iron ore was traditionally melted by burning charcoal. This process produced carbon emissions absorbed by the raw ore to become usable iron. However, charcoal-making was soon deemed unsustainable because of massive deforestation in Britain. Coal appeared the obvious replacement, but its high sulfur content resulted in very brittle metals. In the early 1700s, the discovery of coke solved the problem. Coke is coal burnt in the absence of air the same way charcoal is made by burning wood in the absence of air. Limestone added to the mix removed additional impurities. The result was cast iron. By today’s standards, with 4 percent carbon, cast iron is still quite brittle (the higher the percentage of carbon, the more brittle the iron or steel). But Bessemer revolutionized the industry by observing that blowing hot air through molten cast iron caused carbon to burn off, allowing the steelmaker greater control over carbon content. This led to mass production of cheap, high-grade steel in what are now known as Bessemer furnaces. Improvements on the original design yielded modern day blast and basic oxygen furnaces. Almost all steel today contains less than 2 percent carbon—considerably stronger and less brittle than pre-Bessemer cast iron.

Following Bessemer’s breakthrough, a whole universe of machinery development and infrastructure construction became possible. Productivity skyrocketed, setting the stage for a dramatic increase in living standards over the next century.

The US and global steel industry boomed during this revolutionary period. Factories and cities sprang up to take advantage of this newly abundant material. One of the most revolutionary new industries dramatically affecting world development was railroads. Railroads transported goods and people cheaper, farther, faster, and in greater quantity than ever before. Federal land grants enabled US railroads to grow at a mind-boggling pace. At the end of the Civil War in 1865, roughly 35,000 miles of track existed in the US. By 1900, an estimated 192,000 miles of track had been laid.¹

The introduction of mass-produced strong steel impacted almost every aspect of life. At the turn of the century, 41 percent of the nation’s workforce worked in agriculture. Thirty years later, the portion roughly halved to 22 percent. Laborers were steadily pushed out of the fields by more efficient machinery and followed new opportunities into growing cities. By 2000, America’s agricultural workforce totaled just 2 percent.² A similar process is happening today in emerging markets like China and India. Such tremendous change and growth also produced tremendous wealth (especially in the steel industry). Many of America’s most legendary businessmen made fortunes in iron and steel, including Andrew Carnegie and JP Morgan.

Despite a massive increase in consumption, most metal prices did not spike upwards during the Industrial Revolution. While prices did rise, the pace was relatively well contained as supply increased practically as quickly as demand. From 1880 to 1910, US steel production increased from 1.3 million tons to more than 24 million, making the US the world’s largest steel producer. Dramatic increases in productivity during this time also lowered production costs for raw materials, helping further moderate prices. These productivity gains can be seen in Figure 2.1, which shows the inflation-adjusted, or real, price of aluminum from 1910 through 2007. Other than a price spike during World War I, real aluminum prices have declined dramatically over time, falling 70 percent due to lower production costs. In fact, prior to harnessing cheap energy in the Industrial Revolution, aluminum was actually one of the most precious metals on earth. The top of the Washington Monument is capped with aluminum because, in the late 1800s, it was more precious than gold.

Historically, the Chemicals industry’s growth has hinged on innovation. This includes developing new materials and finding new applications for existing ones. Teflon, for example, was used in various industrial processes for over a decade, including the Manhattan Project in 1941, before it made its way into consumer products like pots and pans in the 1950s. The ubiquitous yellow sticky Post-it Note is another classic example of innovation creating a new product market. The weak adhesive pasted to the back of each note was actually a failed attempt at creating super strong glue. It ended up on the pages of a hymnal church book to mark pages without damaging them. From that, a new adhesive market was created.

This growth translated into tremendous performance for metals stocks. Figure 2.4 shows the performance of S&P Steel industry stocks over the 20-year period after World War II. Starting in early 1949, it surged 564 percent over the next 10-and-a-half years before leveling off again.

The gold standard was adopted by most nations after World War II. According to the Bretton Woods Agreements, most countries pegged their currencies to the US dollar, and the US promised to fix the price of gold at $35 per ounce. Thus, the amount of fiat (paper) money governments could print was constrained because its value was directly tied to an unchanging amount of gold. This policy helped protect the US (and all the countries pegged to its currency) from mismanaging their money supplies and creating excessive inflation. However, it also restricted each nation’s flexibility to support the economy through monetary policy adjustments.

In 1971, the world abandoned the gold standard for a fiat money system. The constraint preventing governments from endlessly increasing money supply as they saw fit was removed and inflation soared. Gold and other precious metals skyrocketed because they were viewed by many as better stores of value than paper money. Figure 2.5 shows gold prices and US inflation from 1966 through 1985. Inflation skyrocketed following the end of the gold standard, and gold peaked in 1980. However, better central banking globally helped tame inflation through the end of the 1980s and onward; gold would not reach those price levels again until 2007. Chapter 4 will cover gold and its drivers in more depth.

Figure 2.6 shows an example of the strain this structural shift has placed on commodity prices. The price of iron ore fell 2 percent from 1990 to 2003, but increased 340 percent from 2003 to 2008 as emerging market infrastructure building kicked into high gear.

But it’s not just emerging markets that are consuming commodities. The developed world simultaneously requires a massive rebuild of its aging infrastructure. For example, the American Society of Civil Engineers recently assessed the condition of America’s infrastructure and gave it a “D.” Repairs to modernize America’s infrastructure are estimated to cost about $1.6 trillion and take about five years.⁴

The combination of initial investment in the rapidly growing emerging markets and accelerating re-investment in the developed world has placed a strain on raw material supply. Chapter 6 will cover the drivers and consequences of these forces in greater detail.