Transmuting in Torchlight II is a process by which the player can combine certain items into new items. It is similar to transmuting in the first game, but features some different recipes and a system that remembers known recipes.
The quality of the transmuted items is an average of the quality of the ingredients one uses. For example, for "A Random Unique" transmutation if one uses four uniques varying in quality 19-32 the resultant item will lie between these quality levels, on the other hand if all four are of 23 quality level then the resultant unique will have 23 quality. This is especially important if you are rolling for a particular set item. The best way to nearly guarantee that you get an item from the same set, is to use items from the same set to transmute. This of course assumes that you have extra items belonging to the same set. (it is often possible to receive a higher level set piece from 2 lower level pieces)
The transmuter first becomes available in Zeryphesh, at the beginning of Act II.