Shiny Metal

Though Gold has captured much of the limelight amid its recent run past $1,000 an ounce, silver has quietly enjoyed its own bull market. The metal is up about 47% so far this year, recently topping $17 an ounce, though it has since slipped to about $16.65.

Silver is caught between two worlds. It’s a precious metal accumulated by investors and central banks as a quasi-currency. And it’s an industrial metal with an increasing number of applications in health care, electronics and even food and clothing, where silver’s antibacterial properties are taking hold.

The question for investors: Which side of silver carries more weight? That answer will help determine where prices head from here.

Silver is mainly recovered as a by-product of lead, zinc, copper and gold mining. For the past few years, demand for silver has exceeded new supplies. Central governments, in selling off their silver inventories, have helped fill the imbalance, says Brad Kopp, director of investor relations at Silver Wheaton Corp., which owns the rights to silver production at certain mines.

The financial crisis, however, has equalized supply and demand. The use of silver in industrial applications slipped to 447 million ounces in 2008, down from nearly 454 million ounces the year before, according to the Silver Institute, a non-profit association. GFMS Ltd., a London-based precious-metals consulting firm, says fabrication demand in 2009 is weaker still and will mark a multiyear low.

Industrial demand is expected to rebound next year as the global economy recovers. Moreover, new applications are emerging that could further increase demand for silver. Nanotechnologies incorporating silver in antimicrobial coatings for medical devices are gaining ground, as is the use of silver in photovoltaic cells in the solar-power industry; a rechargeable silver-zinc battery is also on the way. Under development is a wood preservative made from silver that could replace the long-popular chromated copper arsenate that’s under attack in many parts of the world.

Whether these new technologies will increase the amount of silver used by industry—and, ultimately, a spike in silver prices is hard to judge, though, “because over time alternatives are developed that allow production to switch to a cheaper metal,” says Neil Meader, research director at GFMS. Additionally, some applications, even if they’re widespread, don’t necessarily require a vast amount of silver. “Anything with ‘nano’ in it, for example, doesn’t use very much silver at all,” says John Reade, a metals analyst at UBS Securities in London.

All of that means silver’s precious-metal characteristics are driving prices at the moment. With inflation anxiety mounting, and with the health of the U.S. dollar in question, investors and speculators have been buying silver coins, bullion and exchange-traded funds to hedge against the possibility of a plunging greenback and broadly rising prices for goods and services caused by U.S. fiscal woes and the federal government’s spending and stimulus plans. So far this year investors have sunk nearly $826 million into the iShares Silver Trust ETF, according to Lipper FMI. That’s close to equaling the $911 million pumped into that ETF in all of 2008.

Meanwhile, silver-centric stocks like Silver Wheaton have nearly doubled this year as investors seek a leveraged play on the silver market. As silver prices rise, share prices for mining-related companies respond faster because of the large sum of ounces a company controls.

But if investor demand wanes for whatever reason, says GFMS’s Mr. Meader, “silver prices retreat because industrial demand won’t grow fast enough to match the loss of the investor.”

Moreover, prices likely retreat at a pace faster than gold because silver “is a smaller, much-more volatile market,” says Brian Hicks, co-manager of U.S. Global Investors’ Global Resources Fund.

For the time being, then, silver remains more precious than industrial. And if the two forces propelling the metal’s rising price—fear of inflation and a weakening dollar—reverse course, says UBS’s Mr. Reade, “silver falls maybe into the single digits again.”