Is the global chip shortage an opportunity for investors?
One item links the US/China trade war and post-pandemic supply chain woes. We all use them every day, and you have likely never seen one. It’s the semiconductor chip. In this article, our investment managers look at the global demand for semiconductors and the opportunities this may create for investors, including:
- The semiconductor supply chain and the current global chip shortage
- The impact of demand and supply
- Geopolitical questions, such as competition with China.
Chips with everything…
This invention is right up there with humanity’s greatest achievements. These tiny items, made of silicon, cobalt, and copper, are central to all modern technology and sit inside almost every electronic device, including your car, phone and computer. Nearly everything we do today is based on this minuscule construct of metal and metalloid.
Recently, the problem has been not having enough of them. Last year many car manufacturers, including GM and Ford, either shut down or slowed down production because they couldn’t get enough chips. For example, Ford’s F-150, the best-selling truck in America, was held hostage to a semiconductor with a price of just US$0.25.
What is causing the current chip shortage?
Let’s start with the demand side.
The percentage of a car made up of electronics has been steadily increasing, to about 40% of the total cost of a car today. In 2000, it was around 18%. This seems obvious when you think of safety features like adaptive cruise control, or automated stopping if there’s a pedestrian in front of you.
Secondly, when COVID-19 hit, many car manufacturers assumed car demand was going to fall sharply. So they cut back orders. At the same time demand went through the roof for consumer electronics: Chromebooks, other laptops, webcams, and everything that makes Zoom (and other video call platforms) possible. When it later emerged that car sales weren’t going to be as dramatically impacted by COVID-19 as initially thought, the manufacturers went back to the suppliers, and discovered the chips were not available.
Unfortunately, it takes dozens of weeks to make a new semiconductor, and you can’t turn production off and on quickly. When orders get cancelled, lines are retooled to build other chips. To restore the production line for your chip could take a year.
The biggest customers for chips are mobile phone makers. If Apple places an order, that’s billions of components, and it's a reliable customer, so would be prioritised ahead of automotive companies. Car chips can also be harder to make. Their temperature range, operating lifetime, and failure rates have to be better. While your Chromebook’s light sensor can go bad without endangering lives, your car’s adaptive cruise control can't.
Cars need two kinds of chips: cheaper, older-generation ones (e.g. for anti-lock brakes), and newer ones, e.g. for advanced driver assistance systems; the latter kind are more profitable, so companies prioritise producing them. They are also basically the same chips that are used in smartphones, so they bring car manufacturers directly into competition with phone companies for the already limited supply.
Fighting over a fixed supply
The world has a fixed semiconductor manufacturing capability, but infinite demand. Semiconductor factories are incredibly expensive (say US$10bn) and relatively low margin to build, and might be obsolete in five years. So they depreciate quickly, contributing to chip supply problems.
In turn, the investment industry has rewarded companies that design chips, but don’t actually make them, like Qualcomm, as they provide higher profit margins. Companies like Nvidia, that both design and manufacture, have also performed extremely well in terms of investment growth compared with the global market as a whole.
As with every other manufacturing facility, COVID-19 hit the semiconductor industry. However, the good news is that South Korea and Taiwan, the biggest manufacturers, were much less exposed to COVID-19. The bad news is that Taiwan went through a drought, and you need a lot of water to make chips. TSMC’s daily water consumption is 156,000 tons a day. In the northern part of Taiwan where these factories sit, that's equivalent to 10% of the region’s daily supply of water.
East is east, west is west
If there were no politics, China would be the obvious choice for manufacturing semiconductors.
However, companies in the semiconductor tool chain in the United States have to apply for licences to sell to Chinese companies. The US is rightly worried that China will buy semiconductor manufacturing equipment, reverse engineer it, infringe on the intellectual property, and then make their own semiconductors. China’s explicit goal is to have the number one semiconductor design and manufacturing industry in the world by 2030.
Can China get there? They don’t want to stop at just chips. They want the entire technology supply chain. In the next 10 years, will there be a Chinese operating system running on a Chinese chip, designed by China? If so, we will really have two competing world ecosystems.
We have some soul searching to do about how much our supply chains should reflect geopolitics. How much technology should be country-independent? Should the best ideas (meritocracy) win the day, or will we be in a world where US-led and Chinese-led tech industries don’t cooperate to achieve the best technological advancement possible, but instead view each other with mutual suspicion?
Reasons to be optimistic
We will not be at COVID-19 highs on webcam orders forever. We have always had component shocks in the tech ecosystem, but this was a particularly bad one because we have so many car factories making very expensive products, stymied by the shortage of semiconductors. And since software is now inherent in everything, these shocks ripple beyond technology.
The implications for investors can be seen in two ways. Firstly, a technology supply chain affects plenty of businesses outside the technology sector. Secondly, this presents opportunities to invest in companies that can innovate to make this process more efficient or resilient. One well known electric company has vertically integrated its supply chain. As ever, whenever there is a problem, creative companies will find a solution.
Please remember, if you hold an account with us, you can check your portfolio value at any time through Wealth Online or by getting in touch with your investment manager.
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Investment involves risk and you may not get back what you invest. It’s not suitable for everyone.
Investment involves risk and is not suitable for everyone.