MoneyWeek roundup: How to pick an oil winner

Europe managed to hog most of the headlines this week. But investors might be better off looking beyond the Continent, and worrying about the state of China, says Merryn Somerset Webb on her blog.

China has been the global economy's great hope for some time. But the trouble is, it's in trouble too. One current business trend is particularly worrying. State-owned businesses are abandoning their core interests and turning to "slightly bonkers diversification strategies" to get their hands on more cash.

One grains trader is moving into building luxury hotels. Copper producer Tongling is moving into timber. But "most interesting of all" is a sudden interest in the wine business.

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"Beijing Electric Power Company, a subsidiary of State Grid, is building a 180-hectare chateau and vineyard in Yanqing county. Hainan Airlines is doing something similar, and so are various power utilities and the state-run Shaanxi Coal Industry Company."

So what's going on? "The wine making is probably part-property scam", says Merryn. "Local authorities desperate for cash find it easier to justify selling land for productive purposes than for real estate, but once companies have the land they can then put the planned business on a small part of it and use the rest for the usual hotels, resorts and villas."

But the crazy diversification isn't just about getting around government rules on land sales. It also reflects changes in the Chinese economy. "These big companies are not making much in the way of profits from their core businesses. Take Wuhan: in 2010 it made 185bn in revenue, but its profit margin was a pretty pathetic 2%, half of which came from the non-steel businesses (which make up only about 8% of the business). No wonder it wants to expand."

These cash-rich firms are looking for anywhere to park their money apart from their own core businesses. But the types of stuff they're investing in suggests that there's a shortage of good investment opportunities in China, says Merryn. That's backed up by a decline in Chinese currency deposits in Hong Kong and a recent fall in the country's foreign exchange reserves.

Given that "none of these are things you usually find in very fast growing economies", says Merryn; "another hint for those who still need one, is that China is no longer a very fast-growing economy".

Not everyone agreed with Merryn's take. Dr. Bob' pointed out that China's nominal year-on-year growth in the first quarter of 2012 was 11.4%. He then asked: "What is your definition of 'very fast'? China's growth is the fastest out of the 42 largest economies listed in the back of this week's Economist."

However, jimtaylor' could see Merryn's point. "China's GDP may be growing, but what about share prices and dividends?"

You may or may not agree but if you haven't seen the piece yet, have your say here.

'Dr Copper' agrees with Merryn

Commodity markets certainly believe that China is slowing, says David Stevenson in Monday's Money Morning.

"Before factories can make more finished products, they need extra supplies of raw materials. So if hard commodity prices are climbing, it's a reliable indicator that global demand for goods is growing too." If they're dropping, then it shows they're heading down.

Of the commodities, copper is one of the best economic indicators, says David. "Often described as Dr Copper', this is the metal with a PhD in economics. It's one of the most important and widely-used base metals around. So demand for it rises and falls along with the strength and weakness of the wider economy."

If you compare the copper price with oil you can get an even clearer picture. That's because "the world's overall demand for oil tends to be less volatile, even during quite severe recessions, than it is for copper. And the supply of crude tends to be less variable too. So there aren't such massive swing factors at work here."

So if the copper price rises faster than the price of crude, "it's a clear sign that not only is the world economy expanding, but also that the global growth rate is accelerating".

If the opposite happens, it's a warning sign. And that's exactly what's happening now. David's article has a great graph of the falling ratio, what it means, and what you should be doing about it.

The exciting world of small-cap oil explorers

This week, Tom Bulford was in a cheery mood. Why? One of his tips had struck oil - the share price is now up more than 2,000% since he first recommended it in his Red Hot Penny Shares newsletter. On Thursday, he explained to Penny Sleuth readers why the challenges faced by big oil producers are good news for small oil and gas explorers.

"The problem with being a big oil and gas producer is that each day takes you closer to going out of business unless you can find new reserves to replace those sent to market." The oil majors as the big firms are called realise this and have desperately been seeking new reserves, says Tom.

But they "have not been especially successful. Meanwhile, their smaller and bolder rivals have made significant new discoveries in deepwater locations off the coast of Brazil, Ghana and the Gulf of Mexico, as well as significant onshore discoveries in Kurdistan and Uganda."

Why has big oil, with all its money, lost out? "Big Oil has to go where the big resources are. So the majors are forced into hostile territory where finding oil is a huge challenge. That's why they are leaving the job to small explorers. The attitude is let them take the risk'."

And the smaller companies have done just that some with spectacular results. But despite the success of some of these firms, many remain cheap. That's because, in the wider atmosphere of fear in the stock market, "investors have retreated from the higher-risk exploration plays and headed back towards the producers".

Slow and steady wins the race

Of course not everyone wants to depend on the drill bit. Phil Oakley has a much more cautious investment style, as he explains in Thursday's Money Morning.

"Investing should be simple: you try to put your money into cheap assets that will grow in value over time, and after a number of years, you hope to have enough money to live on, or to buy something that you want", says Phil.

But today's fast-paced news environment, which constantly bombards investors with fresh information, often encourages investors to take a much more short-term approach. That leads to bad decisions and high trading costs.

Phil has two strategies to counter that. One relies on compound interest. "If, like me, you're a conservative investor, then you aim to put your money in assets where a large chunk of your returns is independent of the market's mood swings. You focus on income rather than capital gain - in other words, you are looking for large dividend payments on shares, chunky rents on property or big coupons on bonds.

"By buying assets like this and reinvesting the income you harvest from them, you can build up your savings pot substantially as long as you're patient. Once you've found the right asset, sit back and let the power of compound interest work for you."

So Phil likes firms with generous dividend yields, or preference shares (you can find one of his favourites in the piece you can also learn more about his second strategy, which is to "forget about timing the market").

What you can learn from the Facebook debacle

The fall out from the Facebook IPO continues, with disappointed investors suing anyone they can after the shares fell, rather than performing a tech-bubble-style rocket launch on listing. Only in America, you might say.

We were never keen on the idea of buying into Facebook. But this is a useful lesson as to why pretty much all IPOs are dangerous. MoneyWeek's deputy editor, Tim Bennett, looks at why, in his latest video tutorial.

Before I go I'd like to draw your attention to a story I wrote for this week's magazine. Most analysts agree that renewable energy will only really work' if we can find a way to store the unpredictable supplies of power it creates.

So in this week's magazine, I investigate the fledgling storage sector and pick three (pretty risky) investments that may have found the 'holy grail' of renewable energy. If you're a not subscriber, subscribe to MoneyWeek magazine.

This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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Have a great weekend!

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Merryn Somerset Webb

John Stepek

Tim Bennett

James McKeigue

Matthew Partridge

David Stevenson