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Mish Schneider Are semiconductor chips the new toilet paper?

Lately, despite the recent sell off in the VanEck Vectors Semiconductors ETF [SMH] and related names like Micron [MU], the headlines tell a different story. There is a shortage of semiconductors as chip demand outstrips supply.

The global semiconductor shortage is set to worsen if the supply chain dries up at its source, and that appears to be happening in Taiwan. The chip foundry for the world is suffering from the worst drought in decades.

In past articles, I have written about food shortages due to supply chain disruptions and Mother Nature. Now, the reservoirs in Taiwan are so low, they have been asked to reduce its water use by 7% (water is a major input for semiconductor fabrication).

US semiconductor companies have 47% of the global chip sales market, but only 12% are manufactured in the US. The governments of Taiwan, South Korea, Singapore and China each invest tens of billions of dollars each year in their semiconductor industries. These investments include not just the facilities themselves but also the R&D and tool development necessary to move to the next generation of fabs (fabrication technologies and facilities). In the US, investment is minimal. 

Meanwhile, demand for cell phones, laptops, and chips related to the auto industry such as emissions, vehicle safety, control and driver information systems remains high. Although President Biden has recently ordered a review of supply chains for semiconductors in the US, there is much work to be done.

As a side note, I live in New Mexico. Much of semiconductor manufacturing in the USA is in Arizona and New Mexico. These are the two most water-starved regions of the country.

“It’s a bit like everyone is crazily buying and hoarding toilet papers in a crisis. Everyone is fighting for resources at the same time, and I don’t see a turning point coming yet,” said Advantech chairman KC Liu.

"It’s a bit like everyone is crazily buying and hoarding toilet papers in a crisis" - KC Liu, Advantech chairman

If this shortage is as bad as the headlines suggest, why are chipmakers and the SMH ETF so grossly underperforming the other sectors in the Economic Modern Family like Transportation [IYT]?

One reason is that the whole sector became grossly overbought. Having been in an uptrend since 2012, after nearly 10 years of every dip bought plus the leader of all bull runs, money has shifted to the other sectors (small caps, banks, retail).

Secondly, many of these chip companies are yield sensitive. In the last few weeks, the short-term yields have risen substantially, putting pressure on companies that have to pay more for cost of capital.

Thirdly, technology is also changing. Nvidia [NVDA] (whose CEO, Jason Huang, is pictured above) said it hopes to ease shortages of gaming cards by launching a chip designed for cryptocurrency mining. Nvidia CMP is a cryptocurrency mining processor that could alleviate the chip shortages for gaming. Perhaps cryptocurrency is the penultimate social disruptor.

A company called Bitmain, for instance, has released a new chip specifically for mining Ethereum coins. Dozens of other companies are designing similar chips that take the already specialized GPU into smaller niches, and more companies producing chips means a greater supply and lower prices. It is also possible that unless other big chip manufacturers stay one step ahead, many could go the way of the dinosaur.

"It is also possible that unless other big chip manufacturers stay one step ahead, many could go the way of the dinosaur"

Lastly, with the end of the pandemic in sight, many see the demand for stay-at-home technology waning. Nonetheless, almost everything we buy, even post-pandemic, is going to have a chip in it. Therefore, it is time to weed out the good buy opportunities versus the companies to avoid.

Looking at Nvidia, this correction could be offering investors a low risk buy. Through $520, the stock could recover well, especially if the yields soften. Intel [INTC] has outperformed the chip tech space. Through $64.00, that company could see its stock head to new all-time highs. Taiwan Semiconductor [TSM] looks like the stock to avoid. In fact, a move under $110 could send this stock price down $20-$30.

So, before you hoard your chip companies like toilet paper last year, know which one is two-ply and which ones are a measly single sheet.

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