Artificial Intelligence Investment Opportunities

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This is an AI-generated image depicting a man conducting research to explore investment opportunities in the AI industry

New technologies have the potential to bring about revolutionary changes, such as the emergence of the internet and smartphones, which created a group of companies with market capitalizations exceeding billions or even trillions of dollars. In recent months, the most talked-about topic has undoubtedly been “Generative Artificial Intelligence” (GAI), including OpenAI’s ChatGPT, Google’s Bard, and Baidu’s Ernie, among others. Readers who have tried GAI can attest to its capabilities, which have surpassed expectations, and its impact on various industries is becoming apparent.

In early May this year, the stock price of the online learning platform Chegg, targeted at university students, plummeted almost overnight. The management attributed this decline to the significant increase in students’ interest in using ChatGPT since March, raising concerns about its potential impact on the company’s future growth prospects.

The GAI industry is still in its early stages, making it challenging for investors to accurately grasp investment opportunities. However, two crucial questions come to mind: where does the competitive threshold lie in the GAI field, and which companies currently stand to benefit from GAI?

The GAI industry can be divided into three main parts: the middle, upstream, and downstream. The middle segment consists of GAI neural network model owners, who are responsible for building and training models, such as the three GAI companies mentioned above. The upstream segment consists of infrastructure providers, including hardware graphics processing unit (GPU) suppliers and cloud platform companies. Cloud platform companies purchase GPUs and use them to create systems for neural network model owners. Lastly, the downstream segment includes companies that cater to end customers. They obtain data from model owners and use it to create software and apps that serve users, such as GitHub CoPilot, which assists programmers in writing code.

While many people believe that intellectual property rights may be the most critical competitive threshold, there are currently numerous open-source “large language models” available for use. Additionally, many AI experts request permission from employers to publish research reports in professional journals, fostering a strong atmosphere of mutual learning. In fact, even the core structure of ChatGPT is based on Google’s Transformer model, first introduced in 2017. The “T” in ChatGPT stands for Transformer.

Industry insiders point out that the most crucial competitive thresholds are data quality and computing power, both of which essentially come down to financial resources. Although there is an abundance of free data on the internet, it requires significant investment to clean and prepare the data for use. If GAI is trained using biased data, it may generate a GAI imbued with discrimination and hatred.

As for computing thresholds, Google has stated that training Bard using only one GPU would take approximately 355 years. The price of a project-grade GPU is around 10,000 USD, which implies that the hardware investment alone would be astronomical if one wants to shorten the training time to a reasonable level. Industry insiders estimate that training a large-scale language model can cost up to hundreds of millions of USD. Moreover, training cannot be accomplished in a single step; it requires constant experimentation and failure. How many companies can afford such financial resources to successfully train GAI?

Not only are hardware investments and training costs expensive, but the operational costs of running GAI are also much higher compared to running search engines. Investment banks have calculated that the cost of each GAI response is ten times higher than that of a regular search. GAI model owners are still in the exploratory stage of how to create profitable business models using GAI. In the long run, if companies holding GAI models can eventually transform GAI into a platform similar to Microsoft’s Windows or Apple’s iOS, allowing different software to run on it, generating economies of scale and locking in customers, it would create a difficult-to-exit business model and greatly expand development opportunities.

As for client-side software, since the industry is still young, it seems that no business models with competitive advantages have emerged yet. Apps that use AI to help students with tutoring or assist programmers in coding, for example, currently lack the ability to retain customers in the long term.

In summary, the GAI industry is still a money-burning industry, and large companies have a competitive advantage due to their financial resources. In the short term, upstream companies seem to have more investment opportunities: a significant portion of the expenses for training GAI will be spent on purchasing services from cloud companies, and since GAI requires GPUs for operation, cloud service companies and GPU manufacturers will benefit from this.

Disclaimer

This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.

Investments involve risks. Past performance is not indicative of future performance. You may lose part or all of your investment. You should not make an investment decision solely based on this information. Each Fund may have different underlying investments and be exposed to a number of different risk, prior to investing, please read the offering documents of the respective funds for details, including risk factors. If you have any queries, please contact your financial advisor and seek professional advice. This material is issued by Zeal Asset Management Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong.

There can be no assurance that any estimates of future performance of any industry, security or security class discussed in this presentation can be achieved. The portfolio may or may not have current investments in the industry, security or security class discussed. Any reference or inference to a specific industry or company listed herein does not constitute a recommendation to buy, sell, or hold securities of such industry or company. Please be advised that any estimates of future performance of any industry, security or security class discussed are subject to change at any time and are current as of the date of this presentation only. Targets are objectives only and should not be construed as providing any assurance or guarantee as to the results that may be realized in the future from investments in any industry, asset or asset class described herein.

In respect of any discrepancy between the English and Chinese version, the English version shall prevail.

Has Global Oil Price Peaked?

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Many people, especially car owners, breathed a sigh of relief as the price of Brent crude oil has plummeted by over 30% since the middle of 2022, but is it safe to say the oil prices have peaked? The analysis of different data suggests otherwise.

Let’s talk about the supply first.

Above all, the United States has less room to hold oil prices down by reducing its Strategic Petroleum Reserve (SPR). In the past six months, the United States has released 140 million barrels of crude oil. The SPR has depleted to just under 400 million barrels, which is the lowest level in the past 40 years. According to the weekly report of the U.S. Energy Information Administration, President Biden’s plan to tame energy costs by releasing SPR will be completed in December 2022. The U.S. Department of Energy in October also formulated a plan to replenish the SPR when the price of crude oil is at or below $67-$72 per barrel. These suggest that there is less and less room to bring down oil prices by selling SPR.

Secondly, the capital expenditure of oil companies has reduced significantly in the past two years, which means future supply may be affected. The annual reports of major global oil companies Chevron and Occidental Petroleum show that their capital expenditures have been well below the depreciation rate since 2020. The short-term benefit of this trend is that oil companies can generate a lot of free cash flow for debt reduction and dividend payments. But the disadvantage is that without sufficient investment, it will be difficult to maintain the future production capacity at the current level, particularly when the United States has increased the production of shale gas and shale oil significantly in the past 10 years. The nature of shale oil fields is different from that of traditional oil fields. Without continuous investment, the annual decline in shale oil production capacity will be faster than traditional oil. Unless oil companies significantly increase capital investment in the future, supply reduction is very likely to happen.

Some may ask, “Didn’t Russia’s oil exports drop due to the sanctions? If Russia resumes production after the war, will that offset the potential supply reduction from oil companies?” Surprisingly, according to the oil tanker tracking data, Russia’s oil exports have increased from the pre-war level in the past six months. The main export destinations are non-G7 countries and non-European regions, with China and India being the primary purchasers. This suggests that even if the Russian-Ukrainian war is over, Russia still has limited room to increase production in the future.

Another point worth considering is the exchange rate of the U.S. dollar. The weakening of the U.S. dollar has a positive impact on oil demand because oil prices will fall in non-U.S. dollar regions. For the time being, leading indicators show that the risk of a U.S.  recession is increasing. In addition, the Federal Reserve is expected to slow the pace of interest rate hikes, which will ease the dollar’s appreciation. A weakening USD will drive oil demand and hence oil prices.

The last factor that may weigh on the supply demand equation is the potential demand from China. China is the second-largest oil consumer in the world. In 2022, China’s economic growth slowed down due to COVID restrictions and the real estate crackdown, which made its oil demand milder. But now, demand from China may pick up again since the government has decided to terminate COVID zero and reopen.  As such, we expect there will be an increase in oil demand in the foreseeable future.

All the factors we have discussed may contribute to the return of higher oil prices, so are there any risks of a decline in prices? At present, the main risk lies in whether the global economy will slide into recession in the coming year. However, comparing that with the above 5 supporting factors, the chance of oil prices rising should be greater than the risk of falling.

Disclaimer

This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.

Investments involve risks. Past performance is not indicative of future performance. You may lose part or all of your investment. You should not make an investment decision solely based on this information. Each Fund may have different underlying investments and be exposed to a number of different risk, prior to investing, please read the offering documents of the respective funds for details, including risk factors. If you have any queries, please contact your financial advisor and seek professional advice. This material is issued by Zeal Asset Management Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong.

There can be no assurance that any estimates of future performance of any industry, security or security class discussed in this presentation can be achieved. The portfolio may or may not have current investments in the industry, security or security class discussed. Any reference or inference to a specific industry or company listed herein does not constitute a recommendation to buy, sell, or hold securities of such industry or company. Please be advised that any estimates of future performance of any industry, security or security class discussed are subject to change at any time and are current as of the date of this presentation only. Targets are objectives only and should not be construed as providing any assurance or guarantee as to the results that may be realized in the future from investments in any industry, asset or asset class described herein.