About six months ago, one asset that every investor wanted to invest, thanks to its outstanding performance, was silver. However, just as the precious metal embarked on its journey to a 31-year-high in April this year, showing the steep rise of 80% from $27 an ounce to $48 within a span of three months, the buying frenzy among investors was curbed across the world, including India.

Down but not out

Since then silver prices have not only corrected more than 30% to $34.6 but also face the concerns of a reduction in demand from the industrial segment, which accounts for close to 50% silver usage worldwide. However, silver still features amongst one of the best performing assets in 2011 with year-to-date returns of close to 12% while its average price in the year so far has appreciated by 78% compared to 2010.

Even the domestic prices, which are currently near R56,000 per kg after correcting 25% from its April high of R75,020, have on an average gained 74% in 2011. The average Mumbai spot prices for the year stands at R55,622 for 2011 compared to R31,950 for 2010.

Who?s buying it?

After the global liquidity crisis of 2008 hit most asset classes, including stocks and commodities, investors are increasingly turning towards comparatively safer assets which promise a limited downside and a consistent store of value. While among precious metals gold is always believed to meet these criteria, traditionally, silver was also seen as a store of value and considered to be one of the prominent precious metals.

However, over the years, the use of silver in many industrial applications has diluted its status of being a precious metal and the wider movement in prices indicates its close association with base metals, especially copper.

However, silver?s status as a precious metal regained the investor?s focus from 2010 and is believed to have caused the unprecedented surge in prices in early 2011. This was despite the industrial demand, which comes mainly from electronics products, chemical catalysts, medical and purification industries and more recent and fast developing solar energy sector, showing nominal growth.

The silver?s rise to a multi-decade high was accompanied by the holding of the physical ETP (exchange traded products) reaching an all-time high. Even the speculative positions of traders as highlighted by the net non-commercial net longs in the Comex (Commodities Exchange, an arm of New York Mercantile Exchange) reached a five-month high mid-February this year.

The momentum of the investor demand also caused silver to outperform its precious metal big brother gold for most part of 2011.

As can be seen from the chart, the gold-silver ratio hit a multi-year low of 32 in May 2011. This ratio depicts the number of silver units required to buy one unit of gold; in this case 32 units of silver equalled one unit of gold. Historically, the gold/silver ratio has averaged in the range of 57-61 and had reached an all-time high of 85 in October 2008 when silver prices were crashing along with other base metals while gold showed its resilience in the global economic meltdown and liquidity crunch.

The demand side

A look at the category-wise global silver demand over the last six years shows that even as its use in photography has witnessed a continuous decline due to the rising popularity of digital technology, industrial demand has remained robust. As a result, in the last one decade, silver?s industrial demand has risen from 40% to 55% even as its usage in photography has seen a consistent decline from 24% to about 8% in 2010. In last six years the industrial demand has on average contributed to about 54% of total global demand while demand in photography has averaged just about 13%.

One category of silver usage which has outperformed even the industrial usage is the investment demand. In the last ten years, the demand for silver coins & medals has seen a three-fold jump to 12 million ounces in 2010. Coins and medals are more a typical from of investment demand and are considered part of the fabrication demand. A more direct gauge of investment demand in the last few years has emerged in the form of fund flow into the Silver ETPs.

According to Barclay?s Capital, silver held as physical ETPs that include silver ETFs (exchange traded funds) and ETNs (exchange traded notes) reached a record high of 15,775 tonne in late April. While the ETP redemption gained momentum post-April as the prices fell as low as 38%, in the month of September the flows have again become a 14,500 tonne.

Given the unique demand equation, including a tussle between the industrial and investment demand, which drives the silver prices, the market is expected to see volatile moves in the prices for near to medium term.

On one hand, the sovereign crisis in Europe, and subdued outlook on equity markets could add support to the investment demand as investors look at alternative assets which have potential to restore value. On the other hand, a slowdown in the global economic activity and relatively higher average prices are expected to keep a check on the industrial demand.

Given the high correlation silver holds with other industrial metals, copper in particular, rising concerns of economic slowdown have weighed heavily on prices. As can be seen from the chart, the correlation between the silver and copper prices has strengthened in the recent past to as high as 90%. A positive correlation between two variables means that both the variables tend to move in tandem while a negative correlation indicates the divergence in their moves. This correlation had declined to a two-year low in May 2011, as the prices were driven by the investment demand.

Price outlook

Consequently, most analysts are expecting the silver prices to find the strong support of investment demand while they expect the upside to be decided by the developments in the global economic front. These developments could either lead to an intense fall in the risk appetite of investors, which could benefit silver prices or confirm the likelihood of very weak economic growth, especially in the developed world which through its effect on industrial demand could keep the upside limited.

According to Barclays Capital, silver prices are likely to average $37.2 an ounce in 2011 and $35 in 2012. Citigroup recently raised its forecasts of silver prices for 2012 and 2013 to $32.9 and $27, respectively, from $26 and $22.40 in that order.

For domestic prices, the base has shifted higher due to a significant depreciation of the rupee, which pushes the import cost higher. On the higher side, the prices are expected to find some resistance near the R60,000-mark. The downside is expected to be well supported near R45,000 in the near-term even if there are wide swings in prices.