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Value and Volatility in the Trade War

Written by Briton Ryle
Posted May 20, 2019

I can't tell you how the trade war is going. But I can tell you this PR battle is an instant classic. Like Jimmy Connors' 1991 U.S. Open run, or Tiger's broken leg 2008 U.S. Open victory over Rocco Mediate.

At 39 years old, Jimmy Connors had no business even being at Flushing Meadow that year. And it wasn't a huge surprise that he was already down two sets, had lost the first three games of the third set, and was down 0–40 in the fourth game. 

At 1:35 in the morning, Connors had come all the way back. And that he beat Patrick McEnroe — the brother of his longtime rival John — sealed the deal.

OK, so maybe this little U.S.–China spat isn't that good. Still, I can't look away...

Over the last two weeks, the back and forth has been amazing...

Trump has said: 

My respect and friendship with President Xi is unlimited...

And:

Talks with China continue in a very congenial manner — there is absolutely no need to rush.

Meanwhile, China says raising tariffs is "bullying behavior by the United States," and:

The US keeps saying it wants to talk, but it has kept up with little tricks, which has damaged the atmosphere for #TradeTalks. Without sincerity, there's no point in coming for talks and nothing to talk about.

It's pretty obvious that Trump is trying to smooth China's ruffled feathers. And China is trying to stay ruffled, if that makes any sense. 

Apparently each side has taken to exaggerating just a little. No! You don't say...

I feel like I've done a pretty good job of detailing many of the president's biggest untruths, like: "Our great Patriot Farmers will be one of the biggest beneficiaries of what is happening now."

I came across a great one from China that has some pretty significant implications...

The Memory Market

I first saw this story at Reuters. Then I found this tweet:

#Samsung Electronics will spend over $14 bn in the 2nd phase of investment in its memory #chip plant in Chinese city Xian, reported official Xinhua news agency, citing Samsung Vice President Ji Hyun-ki. The plant will be completed in Jul this year and start production in Q1 2020.

We're talking about memory chips here — NAND and flash memory that are critical components of mobile and laptops these days (because they use less power and take up less space). 

Samsung makes the most cell phones these days. So it makes sense that it makes the most of these memory chips. But either second or third on the list is Idaho-based Micron Technology (NASDAQ: MU).

Now, Micron is one of the most cyclical stocks there is. When times are good, oh boy, are they good. In early 2016, Micron started a run that took it from $10 to $60 in almost exactly 24 months. 

Another 12 months, and it was cut in half. Not a buy and hold, that's for sure. 

But the thing is, the trend has turned so overwhelmingly toward mobile/laptop that many have speculated that maybe Micron is ready to shed that cyclical label and is joining the buy-and-hold crowd...

If you just look at valuations, you can see why this would be a huge opportunity. 

Right now, Micron is valued at $40 billion. And it did just shy of $30 billion in revenue over the last 12 months. Profit margin is just over 40%. Yeah. Its trailing P/E is 3. 

If Micron had the stability of pretty much any other chip stock, it would be at least 500% higher than it is right now. 

Value and Volatility

The type of memory that Micron (and Samsung) makes is sometimes referred to as volatile memory. It doesn't go up and down. But it will go away. Like when you start to enter a number in your phone and you stop. It'll stay there for a little while, but eventually it will go away.

Memory chip prices can ramp very quickly. Chip companies can ramp production pretty quickly. These chips just aren't as complicated as CPUs. From 2016 to 2018, there was a big shortage of memory chips. Now there are too many...

The next generation of wireless, 5G, is coming soon. Current cell phones will need to be replaced to use 5G. That means a huge upgrade cycle is coming. Companies like Samsung and Micron can add production to take advantage of demand. Or they can leave production where it is and take advantage of higher prices.

Now, don't forget, an iPhone counts as an import to the U.S. iPhones added just about $16 billion to the U.S. trade deficit with China last year. You can see where this starts to become a problem...

As China is the world's biggest market for cell phones, it's easy to see why Samsung (and many other chip companies) have operations there. Of the $470 or so billion in global chip sales, less than 5% are actually Chinese chips. 

This is why China hasn't attacked iPhones as part of the trade war. I'm sure they'd love to whack an American icon like Apple. But think of a company like Qualcomm. It got nearly two-thirds of its revenue from China over the last year. Vulnerable? Damn right. But so is China...

China would love to send the message that other countries have no problem doing business there; it's just the U.S. Hence the tweet about Samsung.

For its part, Samsung has said those expansion plans are actually on hold. It is well aware that many companies are changing their supply chains to avoid China altogether, and it has to go with the flow there. And it was only going to be a $7 billion investment anyway.

If Samsung curtails this investment, it could be big news for Micron. Also, that recent settlement with Apple means Qualcomm will be in every 5G phone there is.

All right, so maybe all this isn't Jimmy Connors or Tiger Woods. Still, I am just fascinated by the ins and outs of this trade war...

Until next time,

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Briton Ryle

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.

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