Why silver prices are going through the roof

The price of silver has been on a run for a while now. On Tuesday, silver closed at a price of Rs 62,500 per kg.

In the last fifty days silver has given a return of around 28 per cent (to give you a sense of comparison your savings account gives you a return of 3.5per cent in one year).

In the last one year, silver has given a return of greater than 100 per cent. So what is it that is driving the price of silver to such astonishing levels?

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Silver: The industrial element

While gold may be a favourite with Indians, it is silver that has a lot of industrial uses. This is primarily because silver is the best conductor of electricity, the best heat transfer agent, the best reflector of light, a good lubricant and a versatile catalyst and alloy.

At the same it is also the most malleable and ductile.

As a recent report brought out by Hinde Capital puts it "It is used in photography, electrical applications, particularly in conductors, switches, contacts and fuses. Silver alloys are used in batteries as cathodes."

And as times goes by more and more uses of silver are being found.

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"As a bactericide, silver is used in water purification and air handling systems. Silver is also a natural biocide and is very effective against bacterial infections such...New products using silver's biocidal qualities are being developed each year; clothing, bandages, toothbrushes, door-knobs (flu-protection), keyboards, the list goes on growing."

All these industrial uses ensure that there is a good demand for silver. But that still does not tell us why the silver price is going up so fast.

Is the world running out of silver?

If some of the premier silver analyst of the world are to be believed the world is running out of silver. Some like Adrian Douglas, the proprietor of Market Force Analysis and also a director of GATA (the Gold Anti-Trust Action Committee), even suggest that the world will run out of silver in 2020, and silver will thus become the first element on the periodic element likely to become extinct.

In fact if one believes numbers put out by Theodore Butler, the world's foremost silver analyst, the situation gets very scary.

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Butler has mentioned in several interviews in the past, that silver inventories have declined to 1 billion ounces ( 1 troy ounce = 31.1 grams) from 10 billion ounces in 1940.

In comparison, he says that the world has around 5 billion ounces of gold. So if Butler is to be believed the world has five times more gold than silver.

Of course if this figure is true, the price of silver in the days to come is going to go through the roof.

While Butler's estimate might be rather extreme, numbers clearly show that the supply of silver is less than demand.

The Silver Institute, which tracks silver supply, reports that from 2000 to 2009 (the latest data available), the supply of silver went up to 709.6 million ounces, up from 591 million ounces.

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This shows an increase of around 2per cent per year. The silver demand in 2009 stood at 889 million ounces. So demand was 25per cent more than supply.

The difference between supply and demand was met out of sales of silver scrap.

Why not recycle silver like gold?

Gold is typically recycled and handed down across generations. The same is not possible for silver, given that is largely used as an industrial metal in very small amounts.

Thus it is very difficult to recycle silver. Also at its current price it does not make monetary sense.

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So why not produce more silver?

The earth's crust has 17.5 times more silver than gold, but the production of silver cannot be increased overnight.

A majority of silver (around two-thirds) is mined as a by product of mining of other metals like copper, lead and zinc. So production of silver in a way is linked to the production of other metals.

The skewed gold silver ratio

Silver bulls have been of the view that the price of gold and silver over the period of history has been in the ratio of 15:1.

As Jeff Nielson, editor of bullionbullscanada.com put it in a recent column "For most of the last 5,000 years it has averaged approximately 15:1 until this century, when a combination of developments skewed this ratio to its most extreme imbalance in 5,000 years."

The current ratio of gold and silver is around 35. So silver bulls have been arguing that due to this the price of silver has to go up.

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China is buying silver

It seems the Chinese have also taken fancy to silver. The country imported 122.6 million ounces of silver in 2010, when five years back it had exported 100 million ounces of silver.

This increase in imports has largely been on account of people taking fancy to silver jewellery, as gold jewellery has become extremely expensive.

So should you be buying silver?

The investment argument of silver is pretty simple. The various industrial uses of silver are growing and there isn't enough silver going around that satisfies the demand.

Though sales of silver coins have picked up in countries like the United States and Candada, investors still haven't caught onto investing in silver.

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As you can see from the pie-chart that follows, investing forms a very small part of overall silver demand.

As Jeff Clark, editor of Casey's Gold & Resource Report points out "All exchange-traded funds backed by the metal amount to $20.7 billion.

You can see how this compares to some popular stocks. All silver ETFs(exchange traded funds) combined are less than a quarter of the market cap of McDonald's.

They're about 10per cent of GE, a company that still hasn't recovered from the '08 meltdown. Exxon Mobil is more than 20 times bigger."

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He further adds "While you fetch your magnifying glass, I'll tell you that the market cap of the silver industry is $73.1 billion. It barely registers when compared to a number of other industries I picked mostly at random.

The dying newspaper industry is over 26 times bigger. Drug manufacturers are 213 times larger....And here's the fun one: the market cap of the entire silver market, with all its record-setting prices and stock-screaming highs, represents just one-third of one percent of the oil and gas industry."

So as more and more investors catch onto investing in silver, the prices are likely to rise.

The author can be reached at shonalee.biswas@gmail.com