Bet on suppliers in AI gold rush, says HAMISH MCRAE

There is a bubble brewing in AI stocks. That is the easy bit to predict. The tough part is to say when it might pop. 

The extraordinary surge in the share price of Nvidia, making it for a few hours the most valuable company in the world, is both a symbol and a warning.

It is a symbol of the real and positive impact artificial intelligence will have on the world economy over the next decade and beyond. 

Trouble ahead? There is a bubble brewing in AI stocks

It is also a warning of how hard it is for investors to figure out which companies will be the winners of a great technological revolution – and to put a price on the whole endeavour.

There are lots of reasons to be confident that Nvidia is well placed to benefit, and more of that in a moment. But a valuation of more than $3trillion (£2.4trillion), and talk of it going to $4trillion? 

That’s more than the value of all the firms on the FTSE 100 index. There’s a lot of hope in there.

There is also a warning in what has happened to the share price of electric car start-ups. Tesla has become (and still is) the world’s most valuable vehicle maker, at $570 billion, but that is less than half its peak in November 2021.

A string of other electric vehicle makers have gone bust. Fisker filed for bankruptcy last week. Proterra, an electric bus maker, went under last year. Its assets have been bought by Volvo.

Big rise: The surge in the share price of Nvidia is both a symbol and a warning

Shares in Lucid, now majority-owned by Saudi Arabia’s sovereign wealth fund, have lost more than 90 per cent of their value.

The same goes for investors in Rivian, which makes light trucks, who saw their shares touch nearly $180 in that mad November 2021 – and are now at about $10.

While the global switch to electric vehicles will continue, though perhaps somewhat more slowly than enthusiasts hoped, for those investors who bought into the hype two and a half years ago it has been at best a disappointment and at worst a catastrophe.

Now look at AI. Start with the positive case for Nvidia. It is not an AI company as such; rather it makes the equipment that is essential for the technology to be a success.

Generative AI uses almost unbelievable amounts of computing power, and Nvidia makes the platforms that make it possible for data centres to cope with these demands.

There is a parallel in history, by strange coincidence also in California, where Nvidia is based. It was the Gold Rush from 1848 to 1855, which attracted 300,000 people in the hunt to try to find the precious metal.

A tiny proportion did indeed make their fortunes, but the vast majority came away with very little. But, the key point, most of the lasting fortunes were made by the companies that supplied the prospectors with the kit they needed: the shovels, the pans, the food and lodging, and so on.

There is one such company, founded in 1853 in San Francisco by a German immigrant, that specialised in tough workwear and which is still owned by his descendants to this day. His name was Levi Strauss.

See Nvidia as supplying the mining kit for the gold rush, and at the moment it seems to be the best in class at doing so.

Furthermore, even if the vast majority of AI ventures fall by the wayside, and there is some evidence this is already happening, the companies that can deploy it successfully will do very well indeed.

The markets may be right in believing that these enterprises will include Microsoft and Apple, the other two members of the three trillion dollar club.

And Nvidia? It was founded back in 1993, and it is a very solid business. Yes, it will be continue to be extremely successful, and yes, it is in exactly the right corner of the AI forest.

It may well, like Levi Strauss, be around in another 100 years or more. It’s the valuation that makes me twitchy.

There’s a pattern to all investment bubbles, as we saw in electric cars in 2021, though this one does not feel that extreme. So it may run on a while and rather than popping, deflate slowly.

But for investors it feels like a troubling few months ahead.