Rick Rule, Chairman of Sprott USA, an investment adviser firm, speaks to the Middle East conflict and its effect on oil prices, a bottom in gold, new life in mining shares, and a potential economic disaster waiting to happen.

Oil

The political instability in the Middle East is going to further roil the oil market, Rule said.  The fall of Yemen’s Sunni government to Shiites has reinforced nervousness about the conflict between Shia and Sunni Islam throughout the Middle East, which is leading to dangerous situations. The United States and Iran covertly cooperated to support Shiite militia to retake Tikrit in Iraq from ISIS. The Saudis oppose such US-Iranian cooperation. In Yemen, the Saudis are fighting Shia incursions into the Arabian Peninsula. The Shia-Sunni conflict also plays out in the Straits of Hormuz between the United Arab Emirates and Iran, the point through which 60% of the world’s exported crude flows. Rule argues, “Nervousness about political disruption has roiled an oil market that is currently in oversupply.”

“Until we see some demand increase … the only reason prices will go up is supply disruption.” Rule argued that if “the cold war between Iran and Saudi Arabia became a more open war … if the Straits of Hormuz or the Suez Canal were cut off, that would be a very, very, very different set of circumstances.”

Even without such major events, Rule predicted, “I suspect that people … had better get used to for the next 18 months oil prices that are lower … We’ll come to accept $50 or $60 oil prices, so the up move will surprise everyone as much as the down move. I think the up and down moves will be the result of market forces rather than political interference.”

Gold

Regarding the gold market, Rule said, “… gold is in a bull market in every currency…except the US dollar,” and it has been for 14 months.

Rule further said, “Gold doesn’t need to win the war against the dollar; it just needs to lose the war less badly.” He thinks that is beginning to happen. Physical demand for gold also remains strong, albeit not as strong as two years ago, but that was record-high demand.

One of the things that worked against gold five years ago was high holding costs. The US 10-year Treasury paid 5%, so owning gold cost 5% a year in the foregone interest rate. Today the US 10-year Treasury rate is about 1.7% in a currency that is depreciating, so holding costs are low even while the attractiveness of competing instruments is low. “I feel pretty good about the gold and silver prices, even without a collapse in the US dollar,” Rule said.

Even so, Rule is “not prepared to say that the gold price couldn’t gap lower … but I think we’re closer to the bottom than the top and … I feel better owning it than not owning it. The essence of wealth is enhancing one’s sense of well-being.”

Gold Mining Stocks

Rule sees some daylight in gold stocks. Why? The gold mining industry is beginning to reform itself. “I’ve complained for years that the gold mining industry was its own worst enemy in terms of the misallocation and mal-allocation of capital.” Investors have decided that instead of being a leveraged or marginal industry, they are going to be an efficient industry. Rule sees companies such as Agnico Eagle Mines, Eldorado Gold, Rand Nevada, and Franco Nevada becoming real allocators of capital, and being run like businesses.

Also of crucial importance is that gold is priced globally in US dollars, but the costs for most mining companies are in other currencies, all of which have been sliding against the dollar. For Canadian producers, their currency and costs were on par with the US dollar three years ago. Today, such producers enjoy a 20% off-sale on top of diesel prices that have fallen 45%. The Canadian situation is mirrored around the world and should begin to appear on balance sheets, according to Rule.

Unsecured Bank Deposits

“People who deposit money in a bank are unsecured creditors and the idea that other taxpayers will subsidize unsecured creditors … is stupid,” Rule said. “It should be up to the depositor to ascertain … the financial condition of the bank.” Rule recommended Farmers and Merchants Bank of Long Beach or First National Bank of Alaska as banks with good balance sheets.

“The imbalances in our financial condition are beginning to look like the imbalances that occurred in the middle of the last decade,” Rule said. He warned that governments don’t have the resources to fashion the same sort of bail-out as in 2009, especially since the 2009 bailout “is in large measure attributable to the confidence that investors and voters had in the system.” If there is another financial shock and investors lose confidence in the markets, it “would be catastrophic.” He warned that “the stage is set” for just such a catastrophe.