Will the Silver Rush Kill a Faltering Economy? (STP, EK, SLV, GLD)

One factor driving the price of silver through the roof is its use in industrial products. About half the world’s demand for silver comes from industries such as solar PV makers like Suntech Power Holdings Co. Ltd. (NYSE: STP), film manufacturers like Eastman Kodak Co. (NYSE: EK), and electronics products like plasma TVs. However, demand for silver as an inflation hedge is driving up silver prices for industries that use silver, and those higher costs contribute to slower economic growth.

About 25% of silver demand comes from investors, but they are now driving the bus as they seek a cheaper inflation hedge than gold. The iShares Silver Trust (NYSE: SLV) now holds about 11,000 metric tons of silver in its vaults. Global silver production for 2010 reached nearly 23,000 metric tons, a record high, and about 80% of global demand. The rest comes from recycling.

Global industrial demand for gold is about 10% of total demand. Almost half of gold demand comes from jewellery compared with about 25% of silver demand. Gold demand for investment totals about 40% of the world’s total demand for gold. The SPDR Gold Trust (NYSE: GLD) holds about 1,130 metric tons. Mining contributed about 60% of the world’s gold supply in 2010, with most of the remaining supply coming from recycling.

Because so much more of the silver stock is used for industrial purposes, the price of silver is (or should be) more vulnerable to changes in the business cycle. Currently, however, even as the economy improves only slightly, the price of silver keeps surging.

These price surges result from increased demand from investors, certainly, but because the silver market is so much smaller, and less liquid, than the gold market there is some talk that silver prices are being affected by traders holding massive short positions or attempting to corner the market. These rumors may or may not turn out to be true, but one thing does appear to be happening: the demand for physical silver may overwhelm the supply.

For futures traders that’s not a crisis, but it is very nearly a crisis for industrial users of silver. If they cannot find a substitute for the metal, then they will either have to pay much higher prices and either eat the loss or charge their customers more. Either way, the economic recovery takes a hit.

Kodak reported a first quarter loss of -$246 million, much of it attributable to the silver it uses to manufacture film. Suntech has introduced a solar PV cell that uses copper instead of silver, but so far the substitute accounts for only about 10% of Suntech’s production and sales.

Demand for industrial silver is expected to grow by about 6.5% annually through 2015. If the demand can be met at all it will be at a very high price. Unless of course the bottom falls out of the silver market.

Silver is trading near $49/ounce this morning, and the iShares Silver Trust is up about 1.5%, to $47.91, near the top of its 52-week range of $16.73-$48.35. The SPDR Gold Trust is up about 0.5% after posting a new 52-week high of $150.34. Gold is currently priced at $1,541/ounce.

Paul Ausick