The Daily Reckoning Presents... April 6, 2015 Archives | Unsubscribe Yawning While Yemen Burns Yemen burns… Your editor yawns... Why there will be more oil production before there's less... Then Jim Rickards turns his gaze to our readers to the north… and explains the tribulations and opportunities investors face in Canada... The IRS may not want you to see this... In this shocking presentation -- which has been viewed over a million times -- an ex-IRS hit man blows the lid on how the IRS is stealing from helpless Americans. Believe me, nothing in this presentation makes the IRS look good. That's why I urge you to watch it before we're forced to take it down. Click here to view it now. Baltimore, Maryland April 6, 2015 "The Crisis in Yemen Intensifies as Houthi Fighters Push Deeper Into Aden," reports Time this morning. *Yawn*... *stretch*... *sip coffee*... "Too often we get caught up in the headlines" explained Jim Rickards in this morning's live Strategic Intelligence briefing. Your editor double-times as managing editor for Mr. Rickards in addition to our Reckoning duties. Given the media's hoopla about happenings in the Middle East, we thought an apt topic for this month's SI webinar with Jim was Yemen Burns: An Oil Contagion Update. The stage has been set in these pages. We've camped out on the sidelines, covering our eyes but peeking now and then at the slow implosion of the fracking sector as the price of oil has languished in the $40-60 range. You already know that story. We wanted to get Jim's thoughts on the impact, if any, of fighting in Yemen on his oil contagion thesis. For background, here are some facts we've already covered in these pages... Yemeni oil production sunk to 130,000 barrels per day in 2014 -- less than a third of its peak in 2001 -- due to disruptions and a lack of investment. To make matters more lame, Yemen is the world's 37th largest oil producer. Needless to say, Yemen isn't making or breaking the global crude oil price Perhaps more troubling are the two so-called "choke points" -- waterways that oil tankers use to bring crude to the global marketplace. The one of interest to us today is the Bab-el-Mandeb, also known as the "Gate of Tears." Nearly 7% of all the crude carried by tanker ship around the world passes through Bab-el-Mandeb. "We go online or we pick up the paper and it says, 'Al-Houthi rebels take the airport in Aden.'" continued Mr. Rickards this morning. Somehow, we don't have to be an expert on tribal warfare and the Arabian Peninsula to know that that doesn't sound like good news. "Then, the next day you wake up, and it's 'Al-Qaida affiliate bombs oil terminal in Libya.' "But rather than being a pinball bounced around flipper to flipper… we need to step back and put this in a broader context to see what's going on. "Some of the dynamics in the Middle East have been going on for 1,500 years," Rickards stressed. "We're not talking about something in the Obama administration. We're talking about something that goes back to the seventh century. And they haven't really changed in the whole time, so they may not change now. I would expect this instability to continue… I would expect more bad days… more bad headlines… Oil will be volatile partly for that reason… "What you should expect is that oil will trade somewhere in the $40-60 range for a long time. Meaning this year and into next year. Because that's low enough to kill the frackers but not so low that it hurts Saudi Arabia more than necessary." Saudi Arabia is the swing producer -- they have low enough marginal costs to extract oil at much lower prices than American frackers. "At $60 a barrel" explains Jim, "they're still profitable. In fact, their budget is in a surplus." "So I wouldn't be betting on $20 oil… but I would not be betting on $80 oil, either." $80 is the number Jim offers up as the price frackers need to drill a new well profitably. As for the wells American frackers have already drilled -- the cost to bring oil out of the ground is much lower. "They've got all this debt" Jim goes on. "The estimates vary, but at the low end, it's $2.5 trillion. At the high end, it's $5 trillion. Take your pick. We're talking about multitrillion-dollar junk bond issuance to build all of this infrastructure in the first place. So if I've got all of this money and I've got all these wells and now the price comes down, I might not drill the next well, but I'm going to drill the one I've got, because I want the cash flow at any price to pay my bills." "In the short run," Rickards concludes, "the frackers are pumping as much as possible to cover their principal and interest payments on the debt they have. That oil is cheap. But they're not drilling new wells… the rig counts are going down… they're shutting down production. So the transition from high output to low output doesn't happen overnight. It could take years." This has resulted in a massive oil glut. The Wall Street Journal took those facts and leaned forward last night with the headline "Big Oil Companies Brace for Weak Quarter After the Fall in Prices." "It's going to be ugly," Jason Gammel, an analyst at Jefferies, told the paper. "It's going to be a really bad quarter." In other news… these energy trends -- coupled with the ongoing currency wars -- offer opportunities to the north. Jim has more for you if you read on... Cheers, Peter Coyne The Daily Reckoning P.S. What's above is just the tip of what Jim covered on today's live briefing. If you're unaware, Jim holds a live briefing every month for his Strategic Intelligence readers. We cover one topic in depth… and then go to the lightning round. That's where readers ask questions live and Jim answers them rapid fire. Today, Jim answered the following: Will the Iranian/U.S. deal flood the market with oil enough to drop crude's price below $40? Does the price of oil and U.S. talks with Iran spell the end of the petrodollar agreement with Saudi Arabia? If Jim believes in Peak Oil… and what he thinks the impact of it will be on global growth over the next decade... Is Greece at risk of defaulting or exiting the European Union? If the Asian Infrastructure Investment Bank (AIIB) will pose a challenge to the IMF and their special drawing rights -- a kind of world money. And more! As a reader of Strategic Intelligence, you can review the full briefing plus all eight briefings that we've held before. You'll also have access to a full briefing every month… an issue of Jim's newsletter every month… and a free copy of Jim's new exclusive book, The Big Drop, sent right to your doorstep. All we ask of you is that you pay $4.95 shipping for us to send you the book. Click here for the straightforward deal. P.P.S. I had a busy day today. Besides speaking with Jim, I had an interesting conversation with Rick Rule, chairman of Sprott U.S. Holdings. We spoke about the oil and precious metals markets. You'll want to know where he agrees and disagrees with Jim on the oil markets. I'll feature our conversation later in the week -- it's all part of a new feature we'll be providing to you as an email subscriber. Stay tuned... Fox News Banned This Story: Did you know that a particular type of milk has been linked to cancer? It's so dangerous that it's banned in more than 30 countries, but it's legal in the U.S. You can tell if your milk is "contaminated" simply by looking for a specific four-letter word on its label. If you see it on your jug of milk, I urge you to get rid of the milk immediately. Click here to learn the specific four-letter word you need to look for. The Daily Reckoning Presents... Meanwhile, to the north… Jim Rickards says energy and currency trends are signaling that now is a time to take a closer look at Canadian investment opportunities... ****************************** Oh, Canada! by Jim Rickards Canada is beset by the double decline of energy and its currency. The energy price collapse and the currency wars are global phenomena, but Canada is ground zero for both because of its heavy reliance on energy production and the aggressive actions of its central bank. This story has not been a good one for U.S. investors in Canadian stocks over the past six months. But now may be the time to take a look at some attractively priced opportunities in fundamentally strong companies and a solid economy. The energy story is well-known. Prices for West Texas Intermediate crude oil, an important benchmark, fell from $100 per barrel last July to about $55 per barrel recently, after hitting an interim low of about $45 per barrel in January. That is one of the fastest and most dramatic oil price drops in history. Canada is the world's fifth-largest oil producer, after Russia, Saudi Arabia, the U.S. and China, so the impact in Canada is enormous, as it is for the other top producers. It's important to understand why this oil price drop happened and what those dynamics mean for the price going forward. Canada and the U.S. were the two major participants in the expansion of shale oil production using fracking technology in the past five years. This output was so extensive that it threatened a global oil glut, and lower prices for all producers. This was especially threatening to Saudi Arabia, which faced not only lower prices but lost market share. Saudi Arabia is the only country in the world that can directly affect oil prices on a sustained basis, because it has both the largest reserves and the lowest production costs. Oil can be produced by Saudi Arabia at less than $10 per barrel, whereas shale oil is produced in the U.S. and Canada at an average price of over $70 per barrel. Production costs are much higher for certain individual projects. Saudi Arabia made a decision not to reduce output in order to prop up the price in the face of the glut. The result was the dramatic price collapse that began last summer. However, Saudi Arabia strategically calculated a price for its oil that was low enough to put fracking out of business but high enough to maximize its own revenues and put the least strain on its currency reserves to meet its budget. That strategic target price is $60 per barrel. Of course, markets typically overreact to sudden volatility and overshoot price targets. When the price dropped from $100 per barrel to $60 per barrel between July and mid-December 2014, it is not surprising that the drop continued to the lows of around $45. At that point, the market stabilized and oil rebounded. It now trades in a range of $50–60 per barrel, close to the Saudi target price. From this point forward, the Saudi goal is to maintain oil in that $50–60 per barrel range for an extended period of time, perhaps two years. That will be long enough to shut down most new shale wells and to deplete or shut in the existing wells. Many shale producers will face financial distress because of the heavy debt loads they incurred on the assumption that oil would remain above $80 per barrel. Only when world supply rebalances with demand and the shale industry is severely impaired will Saudi Arabia gradually allow the price to rise. This will result in much larger market share for themselves. The bottom line is that the price of oil is near its intermediate-term lows. An equally important dynamic is affecting the Canadian dollar relative to the U.S. dollar, expressed as the CAD/ USD cross rate. The Untold Story of Ben Franklin's Death We all learned about the life and death of our Founding Fathers throughout our years in school. But there's one detail about Ben Franklin's death that seems to have been forgotten. It's amazing that something that happened 226 years ago could have a huge impact on how you fund your retirement today. Click here and see the incredible story of what Ben Franklin did just 10 months BEFORE his death. The Canadian dollar, affectionately known as the "loonie," has plunged from about $0.94 in early July to about $0.80 today, a 15% decline in just eight months. This loonie crash was caused in part by a series of interest rates cuts initiated by the Bank of Canada, the Canadian central bank. These rate cuts were part of a global currency war that also saw rate cuts or other easing moves by central banks in Sweden, Denmark, Australia, Singapore, China and the European Central Bank. One problem with currency wars is that they are a zerosum game. If CAD goes down against USD, then USD must go up. There is no other possible outcome. This is true globally. All of the countries that have weakened their currencies have done so primarily against the U.S. dollar. As a result, the dollar is at its highest levels in a decade on various indexes. In effect, countries around the world are relying on U.S. consumers armed with strong dollars to be the "buyer of last resort" of their exports of manufactured goods, energy, produce and nontradable goods, such as vacations. The world economy is in recession or slowing down in China, Russia, Europe, Japan and other major countries and regions. In effect, the U.S. economy is being asked to bear the entire cost of adjustment to the slowdown by consuming the world's output using a strong dollar. This creates a conundrum for the U.S. Federal Reserve. The Fed has a clearly stated inflation goal of 2%. Actual inflation is below that target and headed lower. The Fed has also signaled its intention to raise interest rates later this year. However, the impact of a rate increase is to strengthen the dollar, which is deflationary and pushes the Fed even further from its inflation goal. The Fed's twin policies — inflation and a rate increase — are in conflict. The likely outcome is that the Fed will not be able to raise rates for the foreseeable future, perhaps not at all in 2015, and well into 2016. Markets are currently positioned for a Fed rate increase. Once markets realize that the rate increase is not coming, there could be a dramatic reversal of the tendency toward a strong dollar. If the U.S. dollar moves lower, then it is likely the Canadian dollar will move higher. There cannot be any other result in the zero-sum world of currency cross rates. Many analysts are focused on weakness in energy prices or weakness in the Canadian dollar or both. Certainly, the downward moves in recent months -- over 50% for oil and 15% for CAD/USD -- have been dramatic. But these moves didn't happen in a vacuum. The energy price move was the result of strategic calculation by Saudi Arabia. The currency move was the result of strategic calculation by the Bank of Canada. Once these dynamics are understood, it becomes clear that both moves may have run their course. Saudi Arabia will keep the price of oil from going much lower, and the Federal Reserve is getting closer to putting a cap on the U.S. dollar, which means a floor on the Canadian dollar. Oil and the loonie are both probably near lows and look to move up from here. This presents attractive opportunities for U.S. dollar investors in Canadian assets. For carefully selected energy companies, U.S. investors have three ways to win -- company fundamentals, stable energy prices and a rising Canadian dollar. Regards, Jim Rickards for The Daily Reckoning P.S. I've just released a new book called The Big Drop. It wasn't a book I was intending to write. But it warns of a few critical dangers that every American should begin preparing for right now. Here's the catch -- this book is not available for sale. Not anywhere in the world. Not online through Amazon. And not in any brick-and-mortar bookstore. Instead, I've gone ahead and reserved a free copy of my new book in your name. It's on hold, waiting for your response. I just need your permission (and a valid U.S. postal address) to drop it in the mail. Click here to fill out your address and contact info. If you accept the terms, the book will arrive at your doorstep in just a week or two. You'll also get instant access to my latest Strategic Intelligence issue, where I outline two specific ways to profit from a rising loonie. James G. Rickards is an American lawyer, economist, and investment banker with 35 years of experience working in capital markets on Wall Street. 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