Quest for semiconductor supremacy

Opinion

Call it the quest for the most chips. As the companies and governments seek to leverage the potential of artificial intelligence, semiconductors have risen to the top of their shopping list.

For investors, this demand has manifested materially — at least for those who have exposure to the U.S. stock market. The world’s largest publicly traded company, Nvidia Corp., is a semiconductor producer that, until the advent of generative AI search engines like ChatGPT, was best known for making graphics computer chips for video gaming.

Even the other big tech companies that dominate the U.S. stock market rely on Nvidia in most instances to provide semiconductors for their cloud computing and AI-powered capabilities. What’s more, most of these firms also have research and development arms dedicated to designing their own chips.

“On a high level, semiconductors ultimately manage the flow of electricity in equipment,” says Alexander Smahtin, senior analyst at Global X Investments Canada Inc.

The name itself is derived from the idea these chips are often made from silicon, which is not a good conductor of electricity until it is chemically altered in a process called “doping.” At which point, the silicon wafer — a thin slice of crystal — becomes both an electrical conductor and insulator. Hence, a semiconductor.

That’s just the base description.

Today, semiconductor is a broad term that more accurately encompasses the microchips — tiny circuits of ever-growing complexity — embedded on the enhanced silicon wafers. These chips are manufactured in various forms for many industries and consumer uses — smartphones, tablets and electric vehicles, among many other devices.

In short, semiconductors are among the most important manufactured goods on Earth.

“They are ultimately a fundamental building block of all the technology that we have,” Smahtin says.

Demand for semiconductors has reached new heights with generative AI. These large language model searches rely on highly advanced semiconductors to process ever-expanding datasets, ushering in a presumed new industrial age.

“It’s really semiconductors facilitating the ability of those large language AI models to function and move forward,” says Nav Malik, equities research lead for global investment solutions at Scotiabank in Toronto.

Semiconductors are not just of economic importance; they’re of geopolitical significance. Superpowers are clamouring to secure access to their design, production and supply.

Notably, the most advanced AI chips are manufactured in Taiwan.

“It’s a huge advantage that the United States has right now,” says Grant White, investment adviser and portfolio manager with iA Private Wealth in Winnipeg.

The U.S. has deep manufacturing ties with the tiny Asian island nation under continual threat of invasion from China.

U.S.-based Nvidia largely relies on Taiwan Semiconductor Manufacturing Co. Ltd., the most advanced fabricator of chips in the world. Along with smaller companies, Taiwan produces nearly two-thirds of all semiconductor chips.

Both the U.S. and China now seek to build their own fabrication capacities, White adds. It’s why Intel — a flagging semiconductor designer and fabricator — has seen the U.S. government take a stake in it. More recently, Nvidia announced a US$5 billion stake in Intel.

While trying to build capacity, the U.S. and China are also aiming to prevent each other from achieving dominance. To that end, China recently sought to ban its largest tech companies from using Nvidia chips, while the U.S. has at times limited China’s access to them.

Yet semiconductor manufacturing is not an industry that’s easy to gain a quick foothold in, due to its complexity, Malik says. “It’s difficult to design and fabricate advanced semiconductors to the level that is able to handle AI workloads.”

Certainly, demand exists. Companies from almost every corner of the economy want to build their AI capabilities.

One recent report from PwC forecasts AI will fuel semiconductor demand to make it a US$1 trillion industry by 2030.

For investors, semiconductors offer opportunity and risk. “Even when you think about large companies or hyper-scalers (like Meta, Alphabet, Amazon and Microsoft), they’ve already doubled spending compared with a couple of years ago,” Malik says.

“There are now narratives, though, that maybe these companies are spending too much”

That said, the semiconductor industry —tech companies’ high stock price valuations aside — is in a cyclical recovery after bottoming out post-COVID-19 pandemic. Demand soared during the pandemic amid the work-from-home trend, with not enough chips available. Eventually, manufacturing caught up just as demand faded with inflation and higher rates, Smahtin says.

“Now, the semiconductor industry as a whole is emerging from a cyclical downturn,” but its growth is also now powered by two powerful “secular tailwinds” — AI and electric vehicles, he adds. Sprinkle in unprecedented defence spending (increasingly AI focused), and semiconductors have become a strategic and economic commodity of the highest order, albeit a highly advanced, manufactured commodity.

Investors have many ways to get exposure, including investing in Nvidia, White says.

“If you have a five per cent allocation (in your portfolio) to Nvidia, you’re probably going to do just fine.” Still, he cautions the strategy does involve the risk of putting all your eggs in one AI-driven basket.

Investors can also look to specialized funds like the Global X Artificial Intelligence Semiconductor Index ETF (exchange-traded fund) for a more diversified approach. It holds Nvidia, Taiwan Semiconductor and many other companies involved in parts of the value chain.

“It’s really hard to pick the winners,” Smahtin says. “It’s particularly hard in an industry undergoing as much change as semiconductors.”

Of course, given how large some of these companies involved in the semiconductor value chain have become, if you own a diversified U.S. stock mutual fund or ETF, you already have some exposure to semiconductors’ growth, Malik says.

“It is a very competitive business, and there are very large companies that are all trying to develop the most leading edge chips and components.”

Yet when it comes to predicting winners in the race for semiconductor supremacy, “only time will tell,” Malik adds.

Joel Schlesinger is a Winnipeg-based freelance journalist

joelschles@gmail.com