With industrial demand almost exclusively driving the price of silver for years, investing in the white metal used to be simpler. Now investment demand is competing with practical demand to push silver prices ever higher. Investor interest in silver from large U.S. funds could result in as many as 60 new silver plays entering the market this year. These are heady days for silver with a lot of upside in the cards—if played right. Find out how in this Gold Report exclusive.

Andrew Thomson, president and CEO of Soltoro Ltd. (TSX.V:SOL), a Toronto-based silver explorer with projects in Mexico, regularly receives calls from U.S. investors looking to buy a chunk of his silver play. One such investor with a net worth approaching $150 million recently asked Thomson if he could buy a block of 500,000 Soltoro shares. Thomson told him yes but that he would have to get them on the open market.

Times are good for silver juniors.

Thomson estimates there could be another 60 silver companies trading on North American bourses by the end of 2011 and says that’s due to cash-rich U.S. funds seeking northern exposure.

“U.S. players are starting to look at value propositions. They just want to be in silver, and they don’t want the physical metal; they want equity because they want to be able to trade it,” Thomson says. “It’s similar to what happened a few years ago when Chinese, Korean and Vietnamese investors came [to Canada] looking for hard assets. In this case, it’s the U.S. funds that are starting to look at our natural resources. It’s kind of ironic that it takes a strong Canadian dollar for them to start investing in our economy.”

But not all big U.S. funds are making the pilgrimage north or, if they are, the journey is often short-lived. On March 15, Barron’s blogger Murray Coleman reported that U.S. hedge fund managers were buying silver. A week later, however, he told readers “hedge funds in the past week were unloading positions in gold, silver, copper, platinum and palladium.”

“There’s a lot of confusion out there. There are funds that are dumping silver and there are funds that are buying silver. The funds tend to react to the news, and then become the news themselves when they dump large positions. If you watch those big funds’ positions, all you’re going to really see is a bobbing cork. I think net their positions are accumulative,” says James West, editor of the Midas Letter.

David Keating, managing director of equity capital research with Mackie Research Capital, a sizeable Bay Street player in junior mining financings, says the 60 companies figure is likely on the high side but that Thomson’s number is in the ballpark.

“Sixty sounds like a big number but it doesn’t strike me as outrageous,” says Keating. “There’s certainly lots of demand in the market for silver stories.”

Keating notes he’s getting more calls about silver and is currently looking to finance as many as five silver plays. “You’ve got U.S. funds and international funds looking at getting direct toeholds in some of these plays and they are prepared to put up the $5, $10 or even $15 million to get the exploration going. We’ve definitely seen that in the silver names and in the gold names,” he explains.

Keating explains that when you get sustained upward price movement in the underlying commodities, a lot of assets that wouldn’t have earned a second look at lower prices suddenly become attractive at higher prices. He adds, “Companies these days are able to raise capital, so exploration budgets are going up and you’re getting more and more exploration and development. And some of the assets that aren’t getting attention can be spun off into cleaner, pure plays.”

West, until recently, owned a stake in a precious metals mine in Peru and is connected to junior mining plays all over the world, especially those in Latin and South America. He often gets calls from the “who’s who” of Toronto merchant banks and brokerages seeking exploration-worthy assets for capital pool companies (CPCs) or corporate shells.

Brokerages source assets from people like West and—after filing a prospectus and raising seed capital—CPCs buy the assets via a “qualifying transaction,” which is needed to get a listing on the TSX Venture Exchange. It’s often a well-rehearsed dance between brokers and companies.

“If you look at any of the CEOs on the TSX Venture Exchange who have a track record of value creation in public companies, generally, you’ll find them aligned with one or two brokers with whom they do all their business. Usually these groups make money together and they tend to move forward under that arrangement until something goes sideways on a deal, somebody retires, somebody gets sued by their wife. . .whatever,” West explains.

When it comes to silver exploration plays, West says, it’s a seller’s market. “The (property) vendors are demanding a higher price and are willing to sit with their asset on the sidelines, confident that the price is only going to go up. And with every uptick in the silver price, people are willing to pay higher prices for these silver assets,” he says.

Leading the Charge

In early March, newly listed silver junior Argentum Silver Corporation (TSX.V:ASL) optioned Soltoro’s Coyote and Victoria silver-gold properties in a past-producing silver district near Jalisco, Mexico. Argentum paid CAD$255,000 in cash and 5 million shares. Soltoro kept a 3% net smelter royalty on any future production from either Coyote or Victoria.

“Effectively, there is an area play starting in Jalisco that’s been going on for about two years that includes Endeavour Silver Corp. (NYSE:EXK; TSX:EDR), Timmins Gold Corp. (TSX.V:TMM), Silver Predator Corp. (CNSX:SPD), Southern Silver Exploration Corp. (TSX.V.SSV; Fkft:SEG), Soltoro and Argentum Silver,” Thomson says. “It’s not only for silver, but silver is leading the charge.”

Indeed. Two years ago, on March 24, 2009, silver closed at $13.44/oz. And two years later, the white metal finished the day at $37.42/oz. on the NYMEX—a gain of 178%.

West believes we will see $40/oz. silver by the end Q211 and that the white metal could hit $50/oz. by year-end based on not only the typical industrial and investment demand drivers, but also what he refers to as “smart money” entering the space.

By “smart money,” West means the cash behind the big players like Toronto-based Sprott Asset Management. Eric Sprott, the firm’s bearish leader and chief investment officer, is staking his reputation on precious metals. He’s telling anyone willing to listen that gold will see strong resistance above $2,000/oz. and that, during this current bull market in precious metals, the silver:gold ratio—or the number of silver ounces it takes to buy 1 ounce of gold—will return to its historical norm of less than 20:1, perhaps even as low as 10: 1.

Others aren’t quite so bullish.

Riding the Ratio

“[Eric Sprott] is indicating that silver will go to $2,000/oz. I’m not in that camp, but there is a squeeze going on. There’s a lot of new equity traded funds and funds getting into the silver space that are drying up [silver] production, in terms of the delivery of actual physical silver, and that’s what’s driving the price up. It’s a bit of a manipulation from the perspective that it’s the investors who are stepping into [the silver space] and squeezing the supply for the end users. I think that’s very real and that’s why the [silver:gold] ratio is changing,” Thomson says.

The last time the silver:gold ratio closed the gap that much was in 1980 when brothers William and Nelson Hunt attempted to corner the silver market. The ratio peaked at 17:1 before the silver price collapsed on the ill-fated Silver Thursday, which occurred in late March, 31 years ago.

In 2003, when the current bull market in precious metals really started rolling, the silver:gold ratio was roughly 83:1. With silver now approaching $40/oz., the gap has closed to about 38:1 and is steadily narrowing.

“When you’ve got guys like Eric Sprott and Frank Holmes [CEO and CIO of U.S. Global Investors]—guys that are really recognized as ‘thought leaders’ in the space—predicting much higher silver prices, that in itself becomes a fundamental driver for the price,” West says.

Liquid Silver

Sprott put his money where his mouth was and further boosted silver demand by launching the Sprott Physical Silver Trust (NYSE.A:PSLV) in November 2010 at $10 per unit. It closed at $17.38 on March 24 with a market cap of $869 million. The trust trades at a premium to net asset value (NAV) and its silver bullion is tucked away safely in a Canadian vault, a task that took longer than expected. In November, the trust had contracted to purchase 22,298,525 ounces (22.3 Moz.) of silver bullion but by the end of 2010 had taken possession of roughly 21 Moz. The remaining 1.4 Moz. or so did not arrive until well into 2011. The delivery delay clearly demonstrated the tightness in the physical silver market.

“Frankly, we are concerned about the illiquidity in the physical silver market. We believe the delays involved in the delivery of physical silver to the trust highlight the disconnect that exists between the paper and physical markets for silver,” Sprott said in a January press release.

Sprott’s main competition, the iShares Silver Trust (ETF) (NYSE:SLV), has been trading in unprecedented volumes. On March 24, 27 million shares changed hands for a close at $36.12. The $13.2 billion trust is up 121% year-over-year (YOY) from its March 24 close of $16.29.

The Sprott Physical Silver Trust is just one prong in Sprott’s multipronged approach to precious metals investing. Sources close to the situation say he’s buying equity in just about every silver play coming to market and can’t write the checks fast enough. They estimate Sprott’s total bet on silver, including the trust, approaches $1 billion.

David Morgan, editor of the Morgan Report, a silver-focused newsletter, provided Sprott with some names to help him source his silver bullion. Morgan was in the market when silver’s last bull market ended in 1980. He knows what it’s like when the music stops, and he recommends caution.

“The problem with the gold-silver cycle is that it’s such an emotional market because the people who are in it—the gold and silver bugs—have an attachment to [gold and silver] being money. All markets that have a bull market go from undervalued, to fair valued to overvalued; and nothing gets to the extreme overvaluation level, at least in the last bull market, that gold and silver do. What happens at the top of the market—and we’re far from that now, mind you—is that anything with silver in the name of it will go sky high regardless of its merit,” says Morgan.

Thomson agrees but says good assets are good assets in bull and bear markets.

“I think it’s like anything. The museum-quality assets are going to rise to the top, and the stuff that’s smoke and mirrors will always be smoke and mirrors. And, at some point when the market falls apart, the quality will persist and the crap will fall by the wayside,” Thomson says.