The market kicked off strong this week, as news of a “trade truce” between the U.S. and China sparked another all-time high for the Dow and S&P 500 on Monday morning.
After meeting with China’s President Xi Jinping at the G-20 leaders summit this weekend in Japan, President Trump announced that the U.S. will be holding off on any new tariffs while Washington resumes trade talks with Beijing.
Trump also announced on Twitter this weekend that he would loosen restrictions on Chinese tech giant Huawei and that China is committing to buying a “tremendous amount” of unspecified agricultural products from the U.S.
The news immediately provided a major sigh of relief on Wall Street, particularly for trade-sensitive technology stocks. The VanEck Vectors Semiconductor ETF rose 3.8% in morning trading, while individual companies including Skyworks, Micron, and Broadcom gained 7.5%, 6.6%, and 5.7%, respectively.
Those gains, however, soon retracted as initial elation faded and reality set in…
While it’s certainly nice to have President Xi back at the table, a trade deal between the U.S. and China at this point remains anything but certain.
Actions Speak Louder Than Words
Amid Wall Street’s celebration of a U.S.-China trade talk reset earlier this week, a critical and telling announcement was made by Chinese state-controlled technology firm Tsinghua Unigroup. On Sunday, the company revealed that it would be launching its own DRAM chip unit in a move that has the potential to drastically reduce U.S. leverage in trade talks.
For those who don’t know, DRAM is the world’s leading memory technology, used in practically every electronic computing device on Earth. Your phone, your laptop, your tablet, and your PC all rely on DRAM to operate.
DRAM has managed to proliferate because it is relatively cheap and scalable to produce, but it is by no means simple. Manufacturing DRAM requires a high degree of technical expertise (far more so than memory solutions like NAND), which has kept production in the hands of a narrow few.
In recent years, DRAM suppliers have consolidated almost entirely into an exclusive trio of companies. Samsung (South Korea), SK Hynix (South Korea), and Micron (U.S.) provide roughly 95% of the world’s DRAM needs.
Notably, none of these companies is in China, which means the country is highly reliant on DRAM imports. This is true for the semiconductor industry in general, with China importing $260 billion worth of semiconductors in 2017. For perspective, that’s more money than the country spends on oil imports.
In other words, memory chips are an absolutely critical resource for China. As Xi said himself while visiting chipmakers in Hubei Province last year:
Semiconductors are like the human heart. No matter how big a person is, he or she can never be strong without a sound and strong heart.
Unfortunately for Xi, Chinese chips meet less than 20% of the nation’s domestic demand right now, making it majorly reliant on the U.S. and South Korea, a close ally of the former.
China, of course, has made efforts to reduce its reliance on these imports, but with limited success. In late 2018, the U.S. indicted state-owned chipmaker Fujian Jinhua Integrated Circuit Company on industrial espionage charges (for stealing DRAM technology from Micron) and banned the company from importing semiconductor equipment and materials from the U.S.
In effect, this prevented Fujian Jinhua from advancing its DRAM program, which China was relying heavily on.
Now, China is effectively resetting that effort, this time with Tsinghua Unigroup. The move aligns with China’s broader “Made in China 2025” initiative, which is part of what set off calls for a new U.S.-China trade deal in the first place.
It’s worth mentioning, too, that Tsinghua made a $23 billion bid for Micron back in 2015 — the biggest offer on a U.S. company by a Chinese firm in history. Between that and Fujian Jinhua stealing IP, it’s clear how desperate China is to become self-sufficient in DRAM production.
Whether Tsinghua will prove capable of scaling out DRAM production half a decade later is, at this point, unclear, but the announcement at least signals to Trump that China isn’t making any major concessions. The timing is simply too convenient to be seen as a coincidence.
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This Egg May Never Hatch
Ultimately, China aims to produce 70% of its own computer chips by 2025, which is something that would severely undercut U.S. leverage in trade. If China truly believes it can achieve this goal, it would make more sense for the country to stall a trade agreement as it develops the required infrastructure.
In any event, I think Wall Street is giving too much credence to Trump’s optimism on a fair and successful U.S.-China trade deal at this point. There is a very real threat that these talks will fall through again, and if they do, the stakes will be raised to new heights.
Both sides are fully aware of this fact, which is why behind all the renewed rhetoric of cooperation, actions are being taken behind the scenes to reduce joint reliance.
For China, this means closing the technology gap and increasing domestic chip production. For the U.S., it means securing critical resources, namely rare earth elements, of which China has threatened to cut supply.
Fortunately for the U.S., there is a rare earths deposit locked away in North America that’s been waiting to be tapped for a moment just like this, one with a quarter-trillion worth of inferred rare earth elements. Even better news for investors, this deposit is owned by a single company, currently valued at less than $100 million. For more details on this once-in-a-lifetime opportunity, I urge you to review our free presentation here.
Until next time,
Jason Stutman
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