Australia's hidden AI trade

It's become one of the most common criticisms we hear about the local sharemarket. Unlike the US, we don't have a Nvidia, a Microsoft or a Meta. Instead, our technology sector is small, while our market remains dominated by 'old economy' banks and miners.

If you wanted AI exposure, conventional wisdom says you had to look offshore. To the US, or more recently, South Korea and Taiwan.

We believe this narrative is misplaced. In fact, the Australian market may be one of the world's most concentrated AI trades. We just haven't been looking in the right place.

Hiding in plain sight

Quietly powering the Australian market the past 12 months has been the Materials sector. Indeed, when we break down returns, this old-world "picks and shovels" sector has delivered almost 150% of the ASX's total return.

In other words, without Materials, the Australian sharemarket would have delivered a negative return. Even more remarkable, BHP alone accounted for almost half of the market's total return.

The Big Australian is electrifying

With iron ore prices largely stable around US$105 per tonne, BHP's performance may seem surprising. But a closer look at the business reveals an important shift.

Copper has quietly become BHP's largest earnings contributor, driven by growing demand for electrification, data centres and AI infrastructure.

As copper has become a larger part of earnings, BHP's share price has become increasingly tied to the copper price. Since 2020, that correlation has strengthened by around 20% to nearly 0.7*, suggesting investors increasingly view BHP as a leveraged play on the AI build-out.

The market wasn't simply buying miners. It was buying the second derivative of the AI trade.

Software has become the forgotten child

Meanwhile, the Australian technology sector has been thrown under a bus.

With the local sector heavily weighted towards software businesses, Aussi tech has become something of a pariah as investors have rushed into the semiconductor boom in South Korea and Taiwan.

The performance difference has been stark. South Korean technology companies, led by memory chip manufacturers SK Hynix and Samsung, have enjoyed a generational boom. Meanwhile, Australian software companies such as Xero and WiseTech have been treated as AI casualties before the battle has even begun.

In contrast, the returns from our Materials sector has been world leading. 

There is no doubt AI will create distinct winners and losers across technology. Our concern, however, is that markets may be pricing those outcomes with too much certainty.

Semiconductor companies are currently enjoying extraordinary economics, but history suggests these conditions rarely persist. The industry remains highly capital-intensive, fiercely competitive and inherently cyclical. Today's supply shortages and pricing power may prove temporary as capacity eventually catches up with demand.

Software businesses often exhibit the opposite characteristics. They are asset-light, enjoy sticky customer relationships and often possess significant pricing power. Xero, for example, has consistently grown both customer numbers and average revenue per customer in recent years.

Clearly AI creates risks for many software businesses. But with the sector sold down largely indiscriminately, we believe active stock selection has become far more valuable than simply owning the benchmark.

When diversification becomes concentration

On the surface, Australia appears to have missed the AI boom. In reality, our market may be more exposed to the theme than many global indices—just through miners rather than megacap technology.

The irony is that passive investors have become increasingly concentrated in the AI theme without necessarily recognising it. Global benchmarks have become dominated by hyperscalers and semiconductor companies, while the ASX has become increasingly reliant on Materials and copper.

To be clear, we're not bearish on AI. Far from it. We believe the technology will create enormous value over the coming decade, just as the internet ultimately did after the technology bubble burst.

The challenge for investors is recognising that today's winners won't necessarily be tomorrow's winners. Every major technological revolution creates both enduring businesses and temporary beneficiaries. Distinguishing between the two is where active management earns its keep.

Australia didn't miss the AI boom. It’s simply expressed through copper instead of code.