By now you've likely heard of the global chip shortage many times. And, guess what? You're probably going to hear about it for another year or so. So, yeah, you should get used to it... but, better yet, you should understand what is happening. What's causing it? How is this impacting us? How is it being resolved? And, most importantly (since you're following me), how should we invest accordingly to maximize returns?
What exactly is a "chip" or semiconductor?
A computer chip (a.k.a. a semiconductor) is a bunch of electronic circuits printed on conducting material, typically silicon, which forms the building block to the computers and software we use today. Technology has rapidly increased so that these chips are more compact and powerful. Consider looking into Moore's Law for how the rapidly the technology has developed. This, somewhat, started contributing to the shortage today.
What caused the shortage?
- I mentioned technological advances playing a factor in this shortage. And one of those reasons, is Intel (one of the largest global manufacturers) has been unable to keep up with those advances. They've experienced a lot of product delays, resulting in their own shortages, causing it lose key customers like Apple. The demand has since shifted to other companies; but most notably a shift to of the most advanced chip foundries in the world, Taiwan Semiconductor Manufacturing (NYSE:TSM). Taiwan, over the years, has emerged as the global leader of chip manufacturing. Demand for chips have historically been cyclical, but some are saying we are now in a "super cycle" of chip upgrades that could last much longer than a traditional cycle. When all this demand is concentrated to ONE region, and ONE company... what do you think is the natural result?
- COVID-19 is arguably the largest cause of the shortage. When the pandemic started, many companies anticipated a slowdown in global demand and started reducing purchase orders. Car companies were among the first to react to this. However, at the same time, global demand for home office electronics like computers, smartphones, tablets, and even gaming consoles surged. This caused chip manufacturers to switch over production for these smaller chips – which are much more profitable. But, as demand for vehicles caught up (which not a lot of people expected), automakers were left fighting for the precious supply they've now given up.
- The China vs. US technology war is the final big factor in play. The tensions increased with Donald Trump in office, who placed sanctions on Chinese tech companies like SMIC (a partially state-owned semiconductor foundry) and Huawei. Those sanctions caused chip shortages in China, who reacted by buying inventory in advance (further amplifying the problems) and investing heavily in their domestic chipmakers (who are competing for the same resources/components globally). This will be an interesting one to play out.
Why can't we just make more?
As you can see, from the chart above, most of the manufacturing (more than 50%) is with one company in Taiwan. So, TSMC, including every other manufacturer in the world right now, is running at maximum capacity to meet the global demand – being impacted by the three things I mentioned above. In short, we can't simply "just make more".
How is this impacting us?
INFLATION... that's IF you buy anything with a computer chip. Unfortunately, almost EVERYTHING you buy today has a chip – whether it be cars, phones, household appliances, etc. And if you're an investor in the right place, you can of course benefit from these higher prices and increased demand.
How long will it last?
There are varying estimates to how long this last, but most people believe it can take up to a year – or at least until the end of the year. As you know, all manufacturers are operating at full capacity and much of their 2021 production is already ordered for.
How should we invest?
The obvious answer is to buy semiconductor manufacturers, but you have to keep in mind this is typically a cyclical business and any expectations from the current shortage might already be built into the price by investors. So, you'd have to be a believer in the "super cycle" to benefit from this.
The obvious picks, in that case are TSMC, AMD, NVIDIA, Qualcomm for its 5G or even Texas Instruments. They each have a unique play in the semiconductor industry, so it might be worthwhile considering the PHLX Semiconductor Sector Index (SOX).
Intel would be a play on its turnaround story, especially with its CEO Pat Gelsinger's return. They're also investing $20B in two new chip plants in Arizona to compete in providing foundry services. I think they might also be one of the primary beneficiaries for Biden administration's $50B commitment to the semiconductor infrastructure. However, this is a gamble because Intel is at least 3-years behind its competition; and by the time Intel aggressively tries to catchup, the competition isn't sitting still. Thus, although this is a gamble I like, it isn't something I'd go all-in on.
I also like the "picks and shovels" play here with ASML Holding NV (ASML), Lam Research (LRCX), Applied Materials (AMAT), KLA Corp (KLAC), Teradyne Inc (TER), and Entegris Inc (ENTG). But, like I said... some of these might already be crowded plays.
If there's enough interest, I'll do a deep dive on my best plays in this sector for y'all. Let me know what you think!
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