The Silver 'Bullet' Takes a Breather

It has been the silver bullet for many investors, and the best performing commodity so far this year. Now it's taking a breather.

Silver bar and coins
Thomas Northcut | Photodisc | Getty Images
Silver bar and coins

The reason behind the stunningly rapid rise in silver prices in the last few months — the frenzy of speculative interest — may be the main reason for the metal's recent decline.

"The key to silver prices is investment demand," says long-time investor David Morgan, founder of Silver-Investor.Com.

But its underlying strength as an industrial metal is what has attracted many long-term investors. Unlike gold, silver is not only a safe haven and store of value against inflation, growing deficits in the US and Europe and a weakening dollar. It is also an industrial metal with rapidly expanding uses in solar panels, electronic contacts for windshield wipers and navigation systems in cars and cellphones.

"Industrial demand has been a quietly rising tide that's raised prices over an extended period," says Philip Klapwijk, executive chairman of GFMS Limited, the precious metals consulting firm based in London.

GFMS and the Silver Institute forecast industrial demand for silver will rise 37 percent over the next four years to make up more than 60% of total demand for the physical metal.

The increase in industrial demand has more than made up for the decline in silverware and photography in the past year. But the biggest increase in demand for the physical metal over the past year was the 28% jump in demand for silver coins and medals.

It's the demand for silver coins and bars, exchange-traded funds as well as futures and options contracts that has fueled the metal's price rise.

GFMS' Klapwijk estimates investment demand accounts for most of the rise in silver prices from the upper $20s at the start of the year to near $50 last week, and the subsequent fall over the last three sessions.

Meanwhile holdings in silver ETFs which peaked last week have also fallen. Holdings in iShares Silver Trust , the largest silver ETF, have slid 4% since April 25.

Hedge funds and other speculators who increased long positions in silver futures over the past several months have also scaled back their bets dramatically. Last week, the Commodity Futures Trading Commission reported speculative long positions were down nearly 50% from their peak last September and at the lowest point since the first week in February.

However, some traders and investors getting out of their silver positions over the past week are likely new buyers facing high margin rates, says RBC Capital Markets precious metals analyst George Gero. The CME Group has raised margins in silver futures three times in the past week, resulting in a 38% hike in original margin requirements from $8,700 to $12,000 for one futures contract of 5,000 ounces of silver. For some, that may have been too steep a price to pay.