VRA Weekly Update: Guest Post from 30 Year Tech Insider. Must Read. Buy This Dip.
/Good Wednesday morning all.
Given the fear in our markets right now, it’s a good time to share the thoughts of VRA Member Ed from Texas. 30 year veteran insider from the tech/semi industry. His insights on supply chain fears are quite a bit different from what we’re seeing from our financial MSM. Smart money right here.
Thanks again Ed. Please keep ’em coming.
VRA Guest Post. Ed from Texas
“The rise in gold and drop in the stock market these past few days is based on fears that China is going to experience an extended shutdown mode for manufacturing goods for US and Western European customers. The fear level is at an extreme based on the thought that there are no alternatives. My experience in high tech (semiconductor history and PCs) for over 30 years is that China is not the sole source as portrayed.
First most advanced semiconductors for companies like Intel, Apple, QCOM, NVDA, AMD, TI, AVGO, ADI, Micron, etc are built outside China — in US, Taiwan, and Korea. This is key for these companies value their IP to be protected and in addition China Fabs are several generations behind Intel, TSMC and Samsung. China Fabs can build lower cost, commodity Flash memory of lower density and microcontrollers used in toasters, garage door openers etc…They are, however, making a big push to go upstream with Chines government funding. This is where, if Trump wanted to, could cut them off on their investment by denying them Semiconductor manufacturing equipment.
Semiconductor Equipment manufacturing and test Companies are also primarily from Europe and US. ASML, LRCX, KLAC, Teradyne and AMAT are leaders. These companies along with the ones I mentioned above make up the majority of the SMH index and therefore SMH is a nearly pure play ex-china group of stocks that can benefit on upswings in the market. In addition SMH has outperformed Nasdaq by 200% since the 2009 bottom. Part of the reason is that semiconductor companies are also software companies and sell total solutions that are difficult to move off of for end customers. Apple with its CPU+O/S is a vertically integrated model of a semiconductor company+low level software+its user interface. Nvidia is a leader in its space due to leading edge graphics chips plus its software that gamers use to develop their own applications.
Today, the only Fabs that are on shutdown that are know is with Hynix a memory maker in Korea. Samsung in Korea may face that as well. Neither are in the SMH index and Micron would be the beneficiary. Apple uses both TSMC and Samsung for the building of its CPUs. The Samsung facility is in Austin and TSMC is Taiwan. Apple typically flip flops between the two with every generation of phone. Apple also uses other major chip vendors to make Apple labeled chips in their phones and those vendors usually use TSMC.
The second part of the food chain is building the of the actual end products like PCs, servers, iPhones, printers, networking gear. This has seen impact in the china shutdowns to different degrees. It seems Apple and Foxconn are working on ramping production in Shenzhen in southern china — next to Hong Kong and 800 miles from Wuhan. Many of the companies that build products (known has contract manufacturers) have home bases in Taiwan (and USA) and have manufacturing sites in Taiwan and in the coastal provinces on China (Shenzhen and the provinces outside Shanghai). In addition some of the contract manufacturers (CMs) have expanded to Mexico, USA, Eastern Europe and other parts of Asia. We are now seeing some products that were built in china move to other locations. There was an article a few days ago highlighting that the Apple iPad, Watch and iPod has moved to Taiwan for production. Apple has years of experience with many Taiwan OEMs building Macs, MacBooks today so this is not new and Apple would be first in line to utilize these factories. Think of Taiwan as the center where many US OEMs go to start the development of new products PCs, servers, etc and then production occurs there or is sent over to China — in a province near Shanghai. These facilities are managed by the Taiwan Companies. So if China fails, then production can return to Taiwan.
I believe, following this coronavirus scare, that Executives and Boards of public companies will be pushed to diversify their supply chain. Some have plans in place ready to go. Mexico has a vast infrastructure for building electronics gear and can expand. Many also are aware of Mexico’s enormous auto footprint for American and European companies to build for US and ROW. Part of the new trade deal put in place by Trump was to cut down on Chinese auto parts that slipped into Mexico and received no tariffs.
Apple is known to launch a new major phone every two years. It is on track to launch its first 5G phone in September. This post Chinese New Year period is the slow trough for iPhone sales and lasts through Q3 2020. There is heavy anticipation for the iPhone 5G and analysts are predicted a very solid year of revenue. You can bet that Cook and his team will be highly focused getting this out the door for Christmas sales. Analysts in April will surely ask Cook if there are delays in this phone because of china.
History is a good guide for what to expect. In 2011, the Tsunami that hit Japan shutdown an old Renesas Fab that was the only one of its kind building older generation electronics for Toyota and Nissan. The effect on Renesas — which is a very large company was very dramatic (stock dropped more than 20%). Toyota and Nissan had lines down for months for content that was probably in the tens of dollars. This single point failure could be seen in its microcosm as worse than what we have seen in china so far because most production of most gear can be sent to other locations (exception probably in iPhone).
The US has a history of starting at Zero and ramping overnight, even when the infrastructure is not in place. I recommend reading the book Freedoms Forge https://www.amazon.com/dp/B005X0JG48/ref=dp-kindle-redirect?_encoding=UTF8&btkr=1 The US pulled it off in WW2, by outproducing all the other major allies and adversaries in roughly 18–24 months. FDR offered companies non-competitive cost plus bidding and money to invest in new plants. Given that the US is exposed, especially on Pharma products, it is conceivable that Trump could modify his infrastructure plans to include Tariffs and incentives to guarantee Pharma in the US. In addition, I would hope that an infrastructure plan would focus on making the US absolutely dominant in semiconductor manufacturing. There are thousands of good paying jobs that migrated due to high corporate taxes and regulations. However every generation of Moore’s Law requires new equipment and an opportunity to outfit a plant in the US instead of other countries.
China’s huge investment in Huawei is also matched by its desire to be a major player in the semiconductor industry. Fabs are very expensive and can exceed $5B. They have invested in multiple fabs and are moving up the food chain. They cant build yet what Intel or TSMC can do but it is their aim someday. Huawei equipment requires advanced semiconductors as does Apple, AMD and Nvidia…But if the US denies China the advanced chip making equipment from western companies, then the investment is moot. This is known in the Trump administration. It would be a major win for the US is the semiconductor industry footprint increases in the US.”
Buy This Dip.
As Ed stated so well, the changes to our supply chain/manufacturing…the diversification following the onset of Chinese tariffs…has positioned the US to come out of the coronavirus economically stronger than ever. And I recommend reading that book “Freedoms Forge”. I’m well into it now and never knew many of these facts about WW2 and how our manufacturing capabilities resulted in victory. All inside of 2 years from the point FDR turned on the switch.
And you’ll want to read this…you’ll see a hint to exactly what Ed informed us of.
https://www.ftportfolios.com/blogs/EconBlog/2020/2/25/time-to-fear-the-coronavirus
As of writing Dow Jones is+320. Better looking action. And gold wouldn’t be down another $10/oz this am and $43 over last 2 days if this was the onset of a global pandemic. Big tell.
Big shout out to Fundstrats Tom Lee for this excellent work yesterday, essentially calling a bottom. Great follow on Twitter. Tyler got into this on our podcast yesterday.
If you don’t know the name Dennis Gartman, he’s the Paul Krugman of the investing world. Wrong-way Dennis they call him. He just turned heavily bearish.
I expect a much different outcome…as you know. I’m with Warren Buffett, we invest in businesses, not stocks. And when they go on sale, that’s a good thing.
And no, this move lower in gold, silver and miners does NOT spell trouble for this group. NOW is the time to add to positions in this group. This is the precious metals bull market of bull markets.
Until next time, thanks again for reading…
Kip
Since 2014 the VRA Portfolio has net profits of more than 2300% and we have beaten the S&P 500 in 15/17 years.
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