The year 2018 has been a bad one for silver investors and miners. The precious metal, which is renowned for its conductive qualities, has plunged by around 16% since the start of 2018 to be trading at US$14.50 per ounce. This has hit primary silver miners hard, with the Global X Silver Miner's ETF crashing by 27% for that period.
One miner that's been heavily marked down by the market is Fortuna Silver Mines Inc. (TSX:FVI)(NYSE:FSM). It has lost a whopping 31%, creating an opportunity for contrarian investors despite the stagnant silver outlook.
Now what?
Fortuna, which owns and operates the San Jose mine in Mexico and the Caylloma mine in Peru, is also developing the Lindero gold project located in Argentina. That asset is expected to commence commercial production during the third quarter 2019, which will reduce Fortuna's considerable dependence on mining silver to generate revenue.
This will be a positive development because gold, which is less volatile than silver, has remained firm, whereas the white metal's price remains under considerable pressure. The divergence of silver and gold has occurred because while both are precious metals that are perceived to be stores of value, silver is also an industrial metal because of its conductive properties.
As a result, during 2017, manufacturing applications accounted for 59% of all silver consumed, which makes the metal particularly vulnerable to any negative changes in the global economic outlook. The declining industrial demand in recent years combined with fears of lower than expected global growth in 2019 has been weighing on the price of silver.
However, this should ease somewhat in the coming months because President Trump and Chinese President Xi have recently reached a temporary truce on trade. That could avert the looming trade war between the world's two largest economies, thereby reducing the risk of further declines in industrial activity.
The impact of sharply weaker silver can be seen in Fortuna's third quarter results. Despite silver production rising by 11% year over year to 2.2 million ounces and AISCs falling by 3% to US$10.80 per silver ounce sold, Fortuna reported a 33% decline in net income to US$6.9 million.
In the third quarter, it only realized an average price of US$14.80 for each silver ounce sold, which was 12% lower than the same period in 2017, emphasizing the considerable benefits that Fortuna will derive from Lindero once it's operational.
You see, unlike silver, gold has remained firm to trade at around US$1,233 per ounce because of a range of economic and geopolitical fissures, which means that Fortuna's earnings should receive a healthy bump when Lindero begins commercial operations.
In its first year of production, the mine is expected to produce 137,000 gold ounces with all-in sustaining costs (AISCs) of US$528 per ounce produced. Those AISCs are some of the lowest in the industry and underscore the considerable potential profitability of Lindero, especially amid an operating environment where gold is trading at over US$1,200 an ounce.
It should be noted that over the 13-year life of the mine, AISCs will average US$802 per gold ounce produced, which, while significantly greater than for the first year of operation, still underscores the mine's profitability.
According to Fortuna's third quarter 2018 report, Lindero is on schedule to be commissioned during the second quarter 2019 and for commercial production to begin during the third quarter.
So what?
While the outlook for precious metals and especially silver is uncertain, the sharp sell-off of Fortuna has created an opportunity for contrarian investors seeking to boost their exposure to gold and silver.
The commissioning of the Lindero mine will give the miner's earnings a healthy lift and reduce its dependence on silver, thereby offsetting much of the risk associated with the white metals' weak outlook. Once Fortuna consistently reports that Lindero has met forecasts, its market value should receive a healthy boost.
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