And as goes the semiconductor industry, so goes the U.S. economy.

These days, microchips are present in virtually every type of product – from coffee makers to cars: If it plugs into the wall or takes batteries, chances are good there’s a semiconductor inside.

Given the microchip’s ubiquitous nature, the companies that make them – as well as the companies that make the chipmaking equipment – can be viewed as a kind of leading economic indicator. Companies that intend to produce products down the road have to place orders for chips or for equipment now, meaning an uptick in semiconductor-sector business activity today and represent a jump in broader economic growth tomorrow.

“While most chip companies have as yet cited but modest improvement, and forecasts have been held in check, signs of a strong upturn are brewing that will significantly improve upon higher – but still modest – expectations,” Rick Whittington, an analyst with JSA Research wrote in a Forbes column earlier this summer. “High proprietary chip content stocks are poised for breakout sales and earnings, probably quickly returning to levels before last summer’s plunge.”

While consumer spending remains the chief U.S. economic catalyst, accounting for more than two-thirds of gross domestic product (GDP), business spending remains a crucial contributor – especially at a juncture in which consumer confidence has been flayed. Indeed, business spending has stabilized and will return to growth in 2010, semiconductor and other electronics manufacturers believe. In the meantime, they are ramping up production to meet what they believe is a growing consumer demand.

Microchips are used in a broad scope of products: DVD players, automobiles, calculators, coffee makers and televisions, telephones – as well as such stalwarts as personal computers.

Like other economic indicators, electronic-order levels have yet to traverse the economic neutral zone to break into positive territory (marked by the “year-over-year growth” label) but at least the hemorrhaging is subsiding: Sales of semiconductors in North America in the month of July were $3.1 billion, an increase of 5.9% from June, when sales were $2.9 billion, according to the Semiconductor Industry Association (SIA). The continent’s 8% year-over-year decline is significantly less than the rest of the world’s 18.2%, and was the smallest decline of any major market in the world.

“Sales of consumer products such as netbook PCs and cell phones are supporting the modest recovery that is now under way,” said SIA President George Scalise. “Purchases of information technology products by the enterprise sector continue to be tempered by caution and longer replacement cycles. There is evidence of a return to seasonal industry patterns.”

That evidence was further backed up by trade organization Semiconductor Equipment and Materials International (SEMI), which said North America-based manufacturers posted a book-to-bill ratio of 1.06, meaning that $106 worth of orders were received for every $100 of product shipped.

Inventories for many chipmakers are at a lower level compared to their average level for the past three years, Purchasing.com reported, citing market research firm iSuppli Corp. But with the holiday season approaching and retail inventory levels already lowered by a weak consumer demand in the first half of 2009, chipmakers are once again ramping up production, according to iSuppli analyst Carlo Cireiello.

Semiconductor inventory levels are now at “appropriate levels, down from previously excessive positions,” Ciriello told Purchasing.com. Ciriello forecasted in July that chipmakers would begin building inventories 5.5% in the third quarter and 1% in the fourth.

Semiconductors are used in a broad scope of products: DVD players, automobiles, calculators, coffee makers and televisions, telephones. Money Morning took a look at a few of the bigger players (and related companies) in the industry.

Chipmakers Fuel Business Spending

Intel Corp. (Nasdaq: INTC) reported its first quarterly loss in July, losing $398 million after setting aside $1.45 billion in funds to pay a fine from the European Union, which said Intel used illegal rebates to thwart competitors, Bloomberg News reported. Still, the world’s largest chipmaker saw its sales beat analyst estimates and the company late last month boosted its third-quarter revenue forecast to at least $8.8 billion, from an earlier projection of $8.1 billion.

Before Intel raised its guidance, analysts polled by Bloomberg were expecting sales of $8.57 billion. A compilation of analysts’ estimates by Thomson Financial Network now has the chipmaker’s revenue at $8.93 billion. Intel’s revenue in the third quarter of 2008 was $10.2 billion.

“Intel’s second-quarter results reflect improving conditions in the PC market segment with our strongest first- to second-quarter growth since 1988 and a clear expectation for a seasonally stronger second half,” Chief Executive Officer Paul Otellini said.

The increase in Intel’s sales forecast could be attributed to a rebound in PC orders by consumers in Asia, and Edward Jones & Co. analyst William Kreher says the higher guidance bodes well for the technology industry because Intel is a barometer for spending.

“Consumers are driving the strength and the relative strength in PCs,” Kreher told Bloomberg. “We do have an expectation that 2010 will bring renewed demand from the corporate sector as well.”

Chipmaker Marvell Technology Group Ltd. (Nasdaq: MRVL) Chief Executive Officer Sehat Sutardja also sees initial growth by consumer products such as cell phones, e-books and mobile Internet devices. Marvell makes chips that are used in everything from computer hard drives to smartphones such as Research in Motion Ltd.’s (Nasdaq: RIMM) BlackBerry and Apple Inc.’s (Nasdaq: AAPL) iPhone.

“Demand for a lot of consumer devices seems to be picking up from six months ago, both in the U.S. and non-U.S., particularly non-U.S.,” Marvell Chief Financial Officer Clyde Hosein said in an interview with Reuters. “That has picked up substantially since the April time frame and continues to improve or maybe accelerate.”

Investing to Build a Better Chip

If the health of microchip firms is a leading indicator of the outlook for the overall economy, then the outlook for semiconductor-equipment manufacturers is a harbinger of what’s to come for chipmaking sector.

The reason is simple: As chips become more powerful, they also become more complex – meaning the chipmaking process becomes increasingly demanding and deft. So before semiconductor firms can ramp up in a big way, they need to invest in the latest and greatest equipment.

That’s where the equipment stocks come into play.

Capital expenditures – known as “capex” in Wall Street parlance – is a closely watched statistic. Chipmaking firms invest in new gear to expand capacity, to move to the newest technology, or both.

Because of the global financial crisis, so-called “capacity utilization” – the number of chips being turned out as a percentage of what those factories are capable of turning out – plunged to 55.6% in the first quarter of 2009 from 89.7% during the same period a year ago, the SIA reported.

And with more than 40% of the industry’s “fab” capacity sitting fallow, new plants aren’t being built – especially since they cost about $3 billion each, TheStreet.com reported. Several of the equipment players have filed for bankruptcy as a result.

Coming into this year, only three semiconductor firms planned to invest more than $1 billion in new equipment: Intel, Taiwan Semiconductor Manufacturing Co. Ltd. (NYSE ADR: TSM) and Samsung Electronics Co. Ltd.

That’s down from eight companies in 2008 and 16 in 2007.

But the tide appears to be turning – and investments will ramp up as the worldwide economy improves. Already, United Microelectronics Corp. (NYSE ADR: UMC) announced it is boosting its outlays for new equipment to $500 million from the $400 million it planned earlier in the year. Chartered Semiconductor will increase capex to $500 million from the $400 million announced earlier this year. That will be an increase from the $349 million the company spent in 2008.

Chartered Semiconductor Manufacturing Co. Ltd. (Nasdaq ADR: CHRT) is boosting its outlay from the $375 million planned early in the year to $500 million now, according to TheStreet.com. And Toshiba Corp will spend $900 million – down from $3.2 billion last year, but still more than many analysts initially expected.

Additionally, U.S.-based equipment firms will benefit from a weaker U.S. dollar, which makes American products cheaper in foreign-currency terms.

One such U.S. firm is longtime industry leader Lam Research Inc. (Nasdaq: LRCX), which is experiencing an improvement in its business despite a loss in its recently reported fourth-quarter results. Those results included better-than-expected revenue.

During the fourth quarter, which ended June 30, the company said “business conditions improved … contributing to Lam’s ability to show improved financial results for the quarter. Shipments and revenues increased as a result of customer investments to add [leading-edge capacity] in both foundry and memory.”

And while business continues to improve, Lam said it hasn’t lost sight of the need to carefully manage cash and to invest considerable care in choosing where to make next-generation strategic investments.

Lam’s shares have surged nearly 42% so far this year, although they remain 21% below their 52-week high of $37.96. The shares closed yesterday at $30.16, up 5 cents each on a day the major U.S. stock indices were down for a fourth-straight day.

Older PCs Set Stage For Hardware Refresh

Dell Inc. (Nasdaq: DELL) Chairman and Chief Executive Officer Michael Dell is on a mission to save his company $4 billion a year.

The company outsourced 40% of its manufacturing as of its second quarter, helping it achieve an 18.7% gross margin that exceeded analysts’ expectations. Dell’s profit of 28 cents a share also beat Wall Street’s estimate of 28 cents.

CEO Dell sees Microsoft Corp.’s (Nasdaq: MSFT) October 22 release of Windows 7, as well as faster processors from Intel, as the ignition for PC and server purchases next year.

“The size of the installed based of old hardware has never been greater,” Dell said in a conference call with analysts. “I’m here to tell you there’s going to be a refresh cycle next year. It’s not going to come in the first month or the second month, but over the course of the year.”

Dell remains confident that a majority of its business customers are deferring purchases and will accelerate IT spending to take advantage of technology improvements like Windows 7 and Microsoft’s Office 2010, according to Chief Financial Officer Brian Gladden.

“This acceleration remains predicated on an improving economy and related improvements in customer profits and government tax receipts,” Gladden said.

For Hewlett-Packard Co. (NYSE: HPQ), its earnings of 91 cents a share narrowly beat Wall Street estimates of 90 cents, and Chief Executive Officer Mark Hurd sees stabilization, but was reluctant to say the bottom has been reached.

“Business is stabilizing, and we are confident that HP will be an early beneficiary of an economic turnaround and will continue to outperform when conditions improve,” Hurd said.

Both H-P and Dell have already credited consumers in Asia for a rebound in orders in PCs, Bloomberg reported.

Source: Semiconductor and Electronics Makers Anticipate a Bounce in Business Spending Next Year

Unfortunately, there’s one sobering conclusion many investors have so far failed to reach: With grossly over-stimulative monetary and fiscal policies at play, most countries will find it very difficult to recover.

Fortunately, a few well-run countries avoided the fallout from the U.S. housing debacle – as well as the fiscal-and-monetary-stimulus mess that followed. And although they have been badly stung by the slump in world trade, these countries are poised to recover with a satisfying bounce.

One such country is Taiwan, and global markets may be just starting to realize this.

A Backgrounder on a Potential Winner

Because its banks were not active in the United States, Taiwan didn’t suffer directly from the collapse in the U.S. housing market. Taiwan also has not suffered from the typical money-tightening consequence of the financial crisis in the world’s emerging markets; it has no need of foreign bank credit, since it consistently runs a payments surplus and has $300 billion in currency reserves.

However, like all the East Asian countries involved in the supply chain to U.S. consumers, Taiwan did suffer a huge decline in exports in the first three months of 2009; its exports dropped more than 35% in the first quarter – less severe than Japan’s drop, but more than those in Korea and China.

I wrote on this some weeks ago, guessing that the export problem was not fundamental, but simply due to United States de-stocking and the difficulties of obtaining trade finance.

The first-quarter U.S. gross domestic product (GDP) figures published April 29 show that this supposition was correct. U.S. inventories dropped a huge $109 billion; the drop in inventories was by itself responsible for 46% of the 6.1% annual rate of decline in U.S. GDP.

Taiwan’s trade figures for March were already improving somewhat, suggesting that this problem might be alleviating. Recent statements by the major Taiwanese semiconductor companies – firms that are intimately involved in the East Asia/U.S. supply chain – confirm that this transformation is, indeed, taking place. Thus, the Taiwanese economy is likely to at least experience a short-term bounce.

Taiwan’s prospects for sustained recovery are better than many Western countries, because its leadership didn’t panic and jump into the fiscal and monetary policies that are almost certain to cause long-term damage in the countries where leaders opted for such strategies.

In fact, the panel of forecasters from The Economist predicted that Taiwan’s fiscal deficit to be only 5% of GDP for the current fiscal year – less than half the deficit projected for the United States and Great Britain, for example. Its short-term interest rates are below 1%, but it currently has no inflation. And the Taiwanese dollar has declined by 10% against the U.S. dollar since September, making Taiwanese exports more competitive.

The Economist panel expects the Taiwanese economy to shrink by 6.5% in 2009, but that is certainly far too conservative, given the signs of export recovery.

Profiting from the “Other” China

Investors have always worried about Taiwan’s relations with The People’s Republic of China, which claims it as part of the mainland country. However, since the election of the Kuomintang president Ma Ying-jeou last year, relations between Taiwan and Mainland China have improved markedly.

Investors who are aware of Taiwan’s potential have long labeled it as “The Other China.”

On Thursday, China Mobile Ltd. (NYSE ADR: CHL) – China’s largest cellular telephone company – announced plans to invest in Taiwan’s Far EasTone Telecommunications Co. Ltd., a first for Chinese investment in Taiwan (Taiwan has huge investments in China), suggesting that trade relations are no longer cool – but are, in fact, warm.

Three possible avenues into Taiwan seem attractive:

• The Taiwanese exchange-traded fund (ETF).
• And the two largest producers of semiconductors, an industry central to Taiwan’s growth that should benefit from the recent weakness in the Taiwan dollar. In this context, it is notable that the SEMI book-to-bill ratio for the U.S. semiconductor increased sharply in March to 0.61, with the three-month average of orders up 9%. That’s still not a strong number, but it’s moving in the right direction, and matches recent optimism from Taiwan’s manufacturers.

Let’s look at these three Taiwan profit plays:

The iShares MSCI Taiwan Index ETF (NYSE: EWT) is clearly an efficient way to invest in Taiwan; it has risen recently, but is currently trading at a reasonable 13 times earnings.

Taiwan Semiconductor Manufacturing Co. Ltd. (NYSE ADR: TSM) is Taiwan’s largest semiconductor manufacturer. It just reported a tiny first quarter profit on a 54% decrease in sales, but said that its order book was very strong and noted that it expected a sharp rebound in sales and earnings in the second half of 2009.

United Microelectronics Corp. (NYSE ADR: UMC) reported a loss for the first quarter, but just invested $285 million to acquire Chinese semiconductor manufacturer HeJian Technology (Suzhou) Co. Ltd., giving it a substantial foothold in that rapidly growing market. UMC expects a profit in the second quarter and rapid recovery thereafter; it has a strong balance sheet and its free cash flow was positive even in the loss-making first quarter.

Source: Three Ways to Profit As Taiwan Rebounds From the Financial Crisis

–Hold everything. How about a reality check?

–”Brazil’s plan to become one of the world’s biggest oil exporters hinges on exploiting crude 6 miles below the ocean surface in deposits so hot they can melt the metal used to carry uranium to nuclear plants,” reports Joe Carroll in Bloomberg this morning. It gets better (or worse, depending on your perspective).

–”Tapping what may be the biggest oil finds in the Western Hemisphere in three decades will require equipment that can withstand 18,000 pounds per square inch of pressure, enough to crush a pickup truck, pipes that can carry oil at temperatures above 500 degrees Fahrenheit (260 Celsius) and drill bits that can penetrate layers of salt more than one mile thick.”

–The oil industry is becoming metals-intensive. And not just any metals. Our friends at Diggers and Drillers call them ’super metals,’ which sounds about right. It takes a special kind of metal to withstand the heat and temperatures you find in off-shore, deep-sea oil operations. That’s probably the better investment angle than, say, buying Petrobras (NYSE:PBR).

–Think about this for a second. To produce oil from Carioca, Brazil will have to drill to a depth of 10,000 metres (32,000 feet). That is twice as far down as the world’s deepest current production hole. It’s also deeper in the ocean than Mt. Everest is high in the sky. It may as well be Mars or Venus or the moon for as otherworldly as the conditions are.

–The oil industry sure has come a long way from when Colonel Edwin Drake drilled his first well in Titusville, Pennsylvania in 1859. Drillers are going to places they’ve never gone before, and it’s not cheap. For example, Exxon had to develop special pipes for its Sakhalin II project in Siberia because steel pipes were shattering at the temperatures engineers encountered. Bloomberg reports that Chevron destroyed more than a dozen drill bits costing US$50,000 each in a $4.7 billion oil project in Tahiti.

–Where do you even buy $50,000 drill bits?

–Incidentally, did you know that Howard Hughes made his money in drill bits? We didn’t know it either until we researched the subject this morning. Cemented carbide cutting tools, or tools made of tungsten and diamond, are in great demand these days. But in the oil business, it was Howard Robard Hughes Sr. who introduced rotating steel cones to the wildcatters in East Texas in the first two decades of the twentieth century.

–Hughes held the patent on the first rotating tricone bit for 17 years, between 1934 and 1951. This was the peak of exploring and drilling in the Continental U.S. It made Hughes and his more famous and eccentric son Howard very rich. You can afford to be weird when you reach a certain level of wealth. It doesn’t make it right, though. If you want to see a picture of the Hughes drill bit, check this out.

–Resources Minister Martin Ferguson told the ABC that contrary to reports in The Australian last week, the Federal Government has not told Chinese companies to “back off” in their pursuit of their Australian quarry.

–Right. You don’t imagine the Federal Government could come right out and tell China to get lost. It doesn’t want that to happen. But in an interesting coincidence, Stephen Wyatt reports in yesterday’s Financial Review that the, “Chinese may relent in iron-ore negotiations.” This refers to the reluctance of Chinese steel producers to pay a ‘freight premium’ for Australian iron ore (over and above what China pays for Brazilian ore).

–We called the Foreign Investment Review Board (FIRB) ourselves yesterday to see if they publish any information on foreign companies seeking to acquire $100 million or more of an Australian publicly listed company.

–”No we do not,” we were told.

–Fair enough. Here’s what we know. In early April the FIRB shot down a bid by the Shougang Group (China’s sixth largest steel maker) for Mount Gibson Iron Ore (ASX:MGX). We know that Shenzhen Zhongjin Lingnan Nonfemet Co Ltd has a joint bid with and Indonesian firm Herald Resources Ltd (ASX:HER). We also know that China’s state-owned MCC Mining has bid A$400 million one Cape Lambert Iron Ore’s Ltd (ASX:CFE) iron ore projects.

–There are other deals in the works. China Shenhua Group, China Coal Energy, and Yanzhou Coal Mining Co Ltd (listed in Hong Kong and China’s third biggest coal producer by market cap) are all interested in Australian coal. And Chinese iron ore trader Haoning Group would like to buy a stake in iron ore producer Brockman Resources Ltd (ASX:BRM).

–That’s what we know. What we don’t know is what Australia and China are saying to each other behind closed doors. And we don’t know what other Aussie companies might be on Chinese watch lists.

–If the FIRB isn’t going to tell us, there are other ways of prospecting around. Gabriel has been working on some technical and fundamental stock screens that produce at least ten new trading ideas each day (five momentum up, five momentum down).

–We’re experimenting with the variables, but this morning we asked him if a stock with symbol UMC had shown up on any of his screens. “Yes, yesterday it did. On the momentum up screen.”

–The stock came up on our computer screen last night when we were reading up on news from the bauxite market. UMC is the United Minerals Corporation (ASX:UMC). Please read this next note. We are not tipping it and have done no diligence on the stock at all.

–We do note, however, that the company is chasing both iron ore and bauxite in the Pilbara. That got our attention. We aren’t tipping it, but we wanted to know more.