High Stakes When the Chips Are Down: Semiconductors Explained
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Semiconductors have dominated the news cycle as a new gold rush for these clusters of transistors has outlasted the era of easy money. If semiconductors have truly surpassed gold and oil as the lifeblood of the new digital economy, it is important to have a working understanding of this macroeconomic theme and that’s what I hope to help build in this week’s Market Wrap.
What is a semiconductor?
I remember back in school there was a large Periodic Table hanging across the back of the chemistry lab. To the left were the metals which conduct electricity and to the right were the non-metals which do not. If only the world was that simple and things fit into two neat groups. A further group lies between the metals and non-metals (known as metalloids or semi-metals) that share a hybrid combination of the properties of both groups. It’s here we find the foundation of our semiconductors in elements such as silicon which have driven the tech world from its eponymous heartland Silicon Valley.
On these chips are trillions of tiny transistors, devices which act like a gate for electrical charge, providing trillions of binary 0s and 1s. Together these binary interactions underpin the vast digital array of knowledge that lies at our fingertips with computers more powerful than those that sent humanity to the moon. Therefore, the number of transistors we can fit onto each chip determines how powerful it is.
Who are the key players?
TSMC – As one of, if not the largest producer of semiconductors Taiwan Semiconductors Manufacturing Company Ltd is a name you will hear more and more. The manufacture of semiconductors is no simple feat meaning specialist facilities are relied upon. This provides a great strategic advantage to incumbent players over start-ups that try and compete but simply cannot reach the needed scale of production before costs begin to bite.
Nvidia – Recently this US company made a four-standard deviation leap in price into the illustrious trillion-dollar market capitalisation club. Nvidia has focused on GPUs (chips that focus on computer graphics) leading them to be fairly well known in the gaming community and now in the wake of an Artificial Intelligence boom across the general population. Nvidia’s products (GPUs, hardware accelerators and others) help provide the physical infrastructure for Large Language Models that drive advanced programmes such as Open AI’s Chat GPT and Google’s Bard.
Where are the key geographical areas?
South East Asia is a manufacturing empire, and the production of semiconductors is no different. Taiwan is a player that punches well above its weight. This is greatly helped by the prevalence of TSMC and other major players in the industry being based here despite their international outreach. Taiwan also benefits from the ‘Silicon Shield’, a phrase coined by former Deputy National Security Advisor Matthew Pottinger that outlines how the importance of semiconductors and Taiwan’s role in the industry somewhat protects it from its deep-rooted geopolitical targets from neighbouring China. China is also a major player in the semiconductor world with large quantities of domestic production that help defend national interests of bettering the country and its military for the future. With China’s vehement policy of reunifying with Taiwan this potential flashpoint could further turbocharge its dominance in the coming cycle.
South Korea is in a similar situation to Taiwan in that its companies (such as Samsung) largely benefit from a similar incumbent advantage and well-developed manufacturing systems that allow its players to corner the market alongside its neighbour.
Japan has also been able to capitalise on the rise of semiconductors. As a G7 economy, Japan is set to benefit from any flight from Taiwan and China in the wake of heated geopolitical tension. Malaysia is a rising star in the region however, despite its varied manufacturing industries its dominance in semiconductors is yet to be seen.
If your current international rival had a thriving chips industry and wanted to expand it further through hostility, you would do anything to build up your industry as fast as you can. Step in the USA, with several large acts such as the CHIPS Act and Inflation Reduction Act backed by the weight of the American economic machine. President Biden is certainly a different flavour of leader to his predecessor, however in an upcoming election year and a rematch between the two presidents likely the contest is doing more to show their similarities over their differences to international onlookers. The established policy in the US seems to be derived from a fear of the declining US and now protectionist, populist policy is the life support being injected into a waning superpower. Along with hefty pro-business dollar incentives that force your historic allies to question the bilateral nature of your relationship (see my last Market Wrap), the US is certainly putting their chips on the table. Only time will tell if it pays off.
This path has led the EU to pursue more policies that follow the US’s line of thought to remain competitive in the global market by reviewing state subsidy rules that have existed in some form since the bloc’s inception as a commodity forum. The UK is also losing out to the sweet smell of state subsidy across the Atlantic as earlier this year ARM (a leading chip giant) chooses to list in New York over London despite pleas from Downing Street to current owner SoftBank.
How can I express this?
Due to the diversity and rapid expansion of this sector one of the best ways to capitalise on any thematic idea is through an ETF. You can find a link to a slide deck I produced for Queen’s Student Managed Fund in April 2022 here on VanEck Semiconductors ETF. Despite a lot happening between now and then I believe the case we made still stands true today.
Thanks for reading,
Daniel
Disclaimer
This communication is for informational and educational purposes only and should not be taken nor used as investment advice, as a personal recommendation, or solicitation to buy or sell any financial instrument. This material has been prepared without considering any particular recipient’s investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past or future performance of a financial instrument, index or structured product are not, and should not be taken as, a reliable indicator of future performance. I assume no liability as to the accuracy or completeness of the content of this publication.