The global semiconductor shortage is causing headaches for many industries. Manufacturers of PCs, mobile devices, gaming consoles, vehicles, networking devices, and industrial machines are all scrambling to buy enough chips to use in their products amid surging demand for those same products.
Investors looking to navigate this situation and avoid a problematic stock trade would be smart to know what's going on. That starts with being familiar with the six root causes of this ongoing crisis.
1. Intel's big mistakes
Intel (INTC 0.64%), the world's largest manufacturer of x86 CPUs for PCs and data centers, suffered a chip shortage in 2018 after its troubled development of new 10nm chips impacted its production of 14nm chips. It hadn't resolved that shortage when it stumbled again last year by delaying the launch of its new 7nm chips. Intel's missteps caused more PC makers to buy AMD's (AMD -0.35%) CPUs, putting a strain on its supply.
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Unlike Intel, which manufactures its own chips with its internal foundry, AMD outsources the production of most of its chips to Taiwan Semiconductor Manufacturing (TSM -0.34%), the world's most advanced chip foundry. As a result, AMD's growth and market share gains applied more pressure to TSMC's plants prior to the pandemic.
2. Declining memory chip prices
Meanwhile, memory chip prices soared in 2017 and 2018, but declined in 2019 and 2020 amid sluggish demand from the PC and smartphone markets. In response, top DRAM and NAND chipmakers -- including Samsung, SK Hynix, and Micron Technology (MU -0.60%) -- curbed their output before the pandemic.
3. The COVID-19 crisis
In short, the market was already wobbly when the pandemic started last year. However, the pandemic temporarily disrupted semiconductor shipments as global demand for new mobile devices, PCs, and data center upgrades surged in response to remote work, online learning, and other stay-at-home trends.
Most chipmakers recovered from their initial disruptions, and TSMC stayed online because its most advanced plants in Taiwan weren't affected. Memory chipmakers also quickly ramped up their production again in response to that rising demand.
But the chip sector still couldn't satisfy the market's appetite for new chips. TSMC's fabs have already been running at over-100% utilization over the past 12 months, and it recently announced it would spend $100 billion over the next three years to expand its operations. Intel also recently warned that the global chip shortage could last two more years and would require "immense" investments to resolve.
4. Secular tailwinds
Global demand for chips has generally been cyclical over the past few decades. However, the secular growth of new technologies -- including cloud services, 5G networks, and AI services -- is feeding a "super cycle" of chip upgrades that could last much longer than a traditional cycle.
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Connected devices, such as smartphones and cars, require a growing number of chips. Skyworks Solutions (SWKS 1.83%), which produces wireless chips for a wide range of industries, expects each 5G smartphone to use $25 worth of front-end chips, compared to $18 per 4G devices and just $8 per 3G device.
Skyworks also expects nearly three-quarters of all cars to ship with cellular connectivity by 2024. IHS and Deloitte estimate the costs of all electronic components in cars accounted for 45% of their costs in 2020, up from just 18% in 2000, and that ratio could keep rising.
Many chipmakers expected this supercycle to significantly boost their sales prior to the pandemic, but the crisis accelerated many of those trends while temporarily disrupting their shipments. That pressure will likely cause the global chip shortage to drag on.
5. The ongoing tech war
The tech war between the U.S. and China, which intensified under President Donald Trump and is continuing under President Joe Biden, is another pressing issue. The U.S. has already levied sanctions against several big Chinese companies, including SMIC and Huawei, amid national security concerns.
Those sanctions are exacerbating the shortage of advanced chips in China, but they're also spurring the Chinese government to aggressively invest in its domestic chipmakers to reduce its overall dependence on overseas technologies -- which could cause a messy decoupling of the U.S. and Chinese markets.
6. More challenges ahead
The Biden administration recently proposed spending $50 billion to strengthen America's chipmaking sector, but fresh cash probably won't resolve the current chip shortage.
That's because most of the global semiconductor market still relies on overseas companies like the Dutch semiconductor equipment maker ASML (ASML -1.03%), Taiwan's TSMC, and South Korea's Samsung -- which are all arguably more important than most American chipmakers.
Moreover, several recent setbacks -- including a power outage at TSMC, a production pause at Samsung, and a fire at the Japanese auto chipmaker Renesas -- all highlight the fragility of the semiconductor supply chain and its overwhelming dependence on overseas gatekeepers.
What does this shortage mean for investors?
As the semiconductor shortage continues, investors should buy shares of essential companies like ASML and TSMC -- which will profit from elevated demand for their products and services -- while avoiding chip-starved sectors like the auto industry. Investors should also stick with better-run fabless chipmakers like AMD and NVIDIA instead of Intel, which could still struggle with R&D and production issues for the foreseeable future.
