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I've been as surprised as anyone at how far the chip stocks have corrected this year. I won't try to explain it after the fact, because I didn't see it coming -- and I should have.

However, after checking in with my old industry contacts, I remain very enthusiastic about this industry's upcycle. Book-to-bill ratios are still strong, over 1.0. Pricing is firmer and order lead times are lengthening. Industry excess capacity has been absorbed, and managements are preparing for a sequentially stronger second quarter and second half.

Eventual Recovery in Corporate Demand

In 2003, when semiconductor industry sales grew 18%, consumer electronics drove most of the growth, as corporate IT spending never really got going. So it's no wonder that this year's first quarter has seen seasonality in computer sales and some inventory backup. Corporate demand for computers still isn't recovering much, but it will eventually, and that will help drive chip sales higher.

Meanwhile, I'm keeping my positions in leading chip stocks, including Intel ( INTC), Applied Materials ( AMAT), Teradyne ( TER), Micron Technology ( MU), Broadcom ( BRCM) and AVX ( AVX).

I'm getting more confirmation that now is the time in the cycle for commodity components to do better. Prices are firmer for DRAMs and capacitors. Also, worldwide chip capacity is getting tighter, and longer lead times are increasing the urgency for more production and test equipment.

Intel has retraced nearly half of its $20 price rise since the October 2002 low of around $14. Now, at $26.50, it's still up 90%. I'm still looking to make a three- to fivefold gain eventually over this cycle. So far I have about a double in Intel, supported by an earnings forecast of more than $2 a share in 2005.

A concern is growing on Wall Street that the cycle's best earnings growth rate is now past and that the chip sector will languish from here. I couldn't disagree more. Historically, these stocks have done well early in economic expansions, then have underperformed in midcycle while earnings catch up, then outperform as earnings, helped by higher chip pricing, exceed expectations.

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