After dropping almost 60% from its March 2008 peak of $21/ounce, silver appears to be on the rebound: Silver gained 24% back in the first quarter of 2009.

With a track record of strong performance during economic crises, silver seems particularly well poised to weather the current storm, especially the impending threat of inflation. Even our own Brad Zigler pointed out the potential staying power of the silver rally way back in February.

But if silver has so much potential, why is it still so hush-hush among investors?

"Frankly, I don't know," says David Morgan, founder of the Silver Investor and editor-in-chief of the monthly precious metals research guide, "The Morgan Report." As one of silver's most vocal bulls, Morgan has spent more than 30 years educating investors about this often-overlooked metal.

"Personally, I suspect people don't gravitate to silver because the market is so misunderstood," Morgan said in an interview last week. "They just don't understand the how, the where and the why."

Silver: The Green Metal

Unlike gold, says Morgan, which is useful predominately as a store of value, "silver has a dual personality, as both an industrial and monetary asset."

Silver's innate physical properties make it an ideal ingredient in several industrial applications. As nature's best electrical and thermal conductor, the metal is perfect for high-performance electronics or high-voltage circuits. Silver's high reflectivity makes it a must for fine-precision optics, and photosensitive silver compounds are the engine behind photographic film. The metal is even a natural biocide, which is handy in sterilization and treating wounds.

Given silver's valuable characteristics, it's not a big surprise that industrial demand for the metal has risen every year since 2001. The industrial sector now accounts for 54% of global silver usage. (The remainder breaks down into luxury demand - namely, the jewelry trade - and investment demand.)

"Not only is industry the fastest-growing segment of demand for silver, it's also the largest," says Morgan.

Demand could continue to grow long term, since silver is a component in many up-and-coming "green" technologies. Photovoltaic cells in solar arrays require silver coatings. Water purification plants use silver compounds to prevent bacteria and algae buildup. And super-efficient, eco-friendly silver-zinc batteries may soon supplant their lithium-ion cousins in the rapidly growing electric car market.

"Silver is a very clean metal, a very green metal," says Morgan. "And it's also inelastically priced: For some applications, no matter how you price it, you have to use silver."

Another growing demand comes from silver ETFs, which despite their relative newness, have attracted a significant following among individual investors and institutions, like pensions and insurance companies (which can't access the derivatives market). Combined, the silver ETFs added 63.5 million ounces to their stocks throughout the first three months of 2009, and the iShares Silver Trust ETF (NYSE Arca: SLV) now holds over 270 million ounces of fine silver - roughly three-fifths the total silver stocks, says Morgan.

Fig. 1: Historical Silver ETF Holdings

Source: "The Silver Investment Market Report," GMFS, April 2009

"Silver ETFs are far more of a dominant factor in the silver market than gold ETFs are in the gold market," he says. "Gold's just a much bigger market."

What Copper Has To Do With It

Approximately 70% of the silver mined each year is actually by-product, extracted from alloys and ores of gold, copper, nickel, lead and zinc. That means base metals miners and the big diversified natural resources companies often have great control over silver prices - for better or worse.

"If you're a copper miner, you don't care about the price of silver. You just pass it off to your bank for them to sell at any price they like. That puts a lot of pressure on silver prices," explains Morgan.

However, as the global recession has dampened industrial demand worldwide, there has been decreased activity among base metals producers. Less metal being mined means declining silver stocks; the COMEX Dealers Silver Inventory fell sharply between November 2008 and March 2009, dropping from almost 80 million ounces to roughly 70 million.

Additional disturbances in the base metals supply chain could benefit silver's prices further. For example, if the swine flu outbreak becomes a significant pandemic, it could cause supply disruptions from Mexico, which is the world's second-largest silver producer.

Silver, Gold And The Inflation Question

Historically, the fortunes of silver and gold have been inextricably linked, due to their shared use as stores of value. But even though the metals are almost 85% correlated, they're not interchangeable assets.

"Gold's monetary role is primarily in the doom-and-gloom market: If the financial system explodes, then gold will protect you," says Morgan. "Silver, on the other hand, is the best 'good-time' metal out there, because it's used in so many high-tech, high-end products."

Currently, the gold-silver ratio hovers around 70, although in the past few years it has ranged anywhere from 30 to 100. But in 1792, back when the metal was still used for money worldwide, U.S law fixed the ratio at 15.

The Founding Fathers may have been closer to the mark: To a large extent, the current high ratio is artificial - and only jumped after the demonetization of silver in the 1960s. "The natural gold/silver ratio, or the amount of silver coming out of the ground relative to gold, is closer to 8 to 1," says Morgan. "The current gold/silver ratio is just a function of how much people value one metal or the other."

When it comes to inflation, however, investors definitely know their preference: gold. It's nearly a matter of religious belief with many investors that investing in the yellow metal works as a hedge against inflation, but silver has historically performed just as well (and at a lower entry price point, too). "Silver has established itself as one of the best assets to have when dealing with inflationary pressures," says Morgan.

The problem with silver is that historically it's been a far more volatile market than gold, and subject to significant price movements based on the actions of a few big players. For example, in 1997, when Warren Buffett bought 130 million troy ounces of silver, prices leapt from $5 to $8 almost overnight. And in 1979, when the Hunt Brothers tried to corner the silver market, their willy-nilly metal grab sent prices skyrocketing from $11/ounce to $50/ounce in a matter of months. (After the Fed changed the rules on leverage in 1980, silver prices collapsed back below $11/ounces just two months later.)

"Silver's volatility does keep a lot of investors away, and that volatility will continue for at least the next few years," says Morgan. "But if you look at what's going on right now in our financial system and the destruction of the U.S. dollar, you wouldn't have a problem taking a position in gold and silver, because those are probably the two assets that will come out of this thing best."

Building A Silver Portfolio 101

Investors looking for access to physical silver have a range of available options: bars, coins, rounds, etc. (Given the current investor desire for safe havens, bullion demand has been especially strong recently; data for the top four silver bullion coins shows a combined 93% upswing in first quarter sales year over year.) If storage is a problem, U.S. investors can also access physical metal via the aforementioned iShares Silver Trust ETF.

Investors can also try silver futures, which trade on the COMEX, or a futures-tracking ETF like the PowerShares DB Silver Fund (NYSE Arca: DBS). But Morgan prefers top-tier mining companies over futures plays. "With mining companies, you can get leverage for both the upside and downside, just like a futures contract - but they carry far less risk," he says.

Although dozens of multi-metal miners provide access to silver, few pure-play silver mining companies exist. Some include:

* Pan American Silver (NASDAQ: PAAS), one of the world's largest primary silver miners, which operates eight mines in Mexico, Bolivia and Peru.

* Silver Wheaton Corporation (NYSE: SLW), another major silver mining company operating mines in Mexico, Sweden, Peru, Greece and the U.S.

* Silver Standard Resources (NASDAQ: SSRI), which doesn't itself mine for silver but rather owns stakes in the mine properties. Their holdings include projects in Argentina, Peru, Mexico, Canada, Chile, Australia and the U.S.

How High Is High? No One Knows

Morgan predicts that continuing financial instability will push silver higher throughout 2009. "I think silver will establish a wide trading range this summer," says Morgan. "But by early fall, we should start to see strength. By late 2009 into first quarter 2010, I'm looking for it to go beyond the $21 level it established in 2008."

The key, says Morgan, is the $25/ounce price point. "Once we get to that level and stay there for at least three or four consecutive trading days, I think you'll start to see a real acceleration in the silver market," he says.

"After that, how high is high? No one knows. There's no upside resistance once we break through that level, because anybody who owns silver is going to say, 'Well, I'm not going to sell now.' And that's when we'll see those markets really start to accelerate."

One of the most dynamic companies I have ever come across is a hidden gem. Silver Wheaton (SLW) should be a core position in everyone's portfolio for the following reasons.

The first reason is obviously valuation - I mean this is the stock market after all. It recently acquired Silverstone, increasing previous guidance of 14m/oz to 18m/oz. The company will then reach 25m oz in 2010, 29m/oz in 2011 and 33m/oz by 2012.

But isn't mining a very risky business? Yes mining does come with its share of risks, but that's the thing. Silver Wheaton does no mining. It is purely a royalty company, which is now comprised of 12 streams around the world. For those who don't know, a royalty company pays money up-front to miners in need of financing in return for a contractual percent of the future product. So yes, Silver Wheaton has been a very risky company in the past, and has come close to being unable to service its debt. But that is all in the past now - the company had $220m in debt just 6 months ago and has reduced that to just under $150m, which excludes the debt repaid so far this quarter, most likely in the neighborhood of $40-75m.

WAIT, HOW DOES THIS WORK? Well it is rather simple, and anyone capable of doing elementary math can calculate a rough estimate of operating income. Silver Wheaton pays on average $4/oz for each oz of silver produced from its streams (technically $3.93 for 2009 and subject to a maximum increase of 1% per annum). Silver, which is currently trading at $14/oz as I write this, would provide $10 of operating income per ounce. I expect silver to skyrocket over the next 3-5 years, which essentially makes SLW a pure play on this precious metal. The company has 5 people in the entire company (remember no actual mining takes place), whose combined salaries don't even make it to the financial statements due to the insignificance of that amount.

WHAT ABOUT TAXES? Though a Canadian based company, Silver Wheaton was allowed by regulators to be headquartered in the Caymans. I think we all know that means NO Income Tax! That's right, unless the tax laws change, SLW will only pay capital gains tax on investments. So putting this all together, GROSS REVENUE- INTEREST EXPENSE = NET INCOME = FREE CASH FLOW. For those unfamiliar with the meaning of the latter, free cash flow is the true measure of earnings for investors. What about net income? Well yes, net income is the true measure of earnings for the company, but in order for the business to continue operating, a significant portion of that must be reinvested into such things as inventory, plant, property, equipment, and cash (in order to ensure that viability, should the company hit hard times). SLW will likely continue to make additional purchases should the opportunity present itself, but it can continue operations for over 20 years even without doing so. It gets better - as mines develop, they often lead to additional reserves, thus either increasing annual production for SLW or an extended royalty life (depending on the conditions of the contract).

WHY SILVER? Chances are you have stumbled upon this because you believe there will be substantial Inflation in the near future. Gold and Silver have historically been inflation hedges throughout history. They are and have always been recognized as international currencies (although not recognized by the government). This has to do with the history behind them, as they have been used for over 5,000 years. Gold has been for larger purchases and silver for the small denomination every day purchases. As silver prices rise, the contracted purchase price can only increase 1% per year of the previous year's purchase price. This means inflation is a positive because net margins increase!

IS THAT THE ONLY REASON? Not by a long shot. Silver is being used more and more in technology (Silver will play a substantial role in the future of batteries, not to mention other technological equipment) and as we all know, it is important for industrial production. The majority is mined as a byproduct from base metals (which have come to a halt due to the recession). In other words, the supply has drastically fallen without the market taking notice. A clear buy signal is flashing as there is currently more gold above ground than silver, yet the industrial demands for silver will rebound in the near future, and when they do, you'd better watch out.

Even if inflation were to be low to moderate in the future, Silver is still compelling as it is used heavily in solar panels. The "Green" craze the world seems to be in, will cause the demand to increase even if all these alternative energy theories turn out to be nothing but hogwash. But what has really caught my eye in my research is the fact the next generation of batteries, both those used for everyday electronics and the much larger ones, will contain substantially more silver than the current lithium Ion batteries.The next generation batteries currently referred to as Silver-Zinc or ZMP have many advantages over the current standard. Most importantly is the fact that they can keep their charge and maintain that amount of energy throughout the life of the battery. They last 40% longer than lithium-ion batteries and are 95% are recyclable which will garner the attention of the "green crowd". There have been talks of this battery rolling out as soon as the fall of this year. As laptops, cellphones and other semi-conductor equipment switch over the demand will increase much faster than the supply every could.

Looking at the big picture, BRIC countries in addition to the next generation of emerging countries drive the demand for silver and therefore the price for a prolonged period of time coupled with the future of silver, and its uses should send the long term price of silver to the mid-20's or higher.

So how much could it be worth? Call me crazy but I think the intrinsic value of SLW is in the range of $40-$50. No I'm not the type to make such a bold call, but those are my conservative estimates. Avoiding any dragged out calculation, let's just project 2012 profit. Assuming we experience the inflation of the late 70's (which is very conservative), silver will trade between $30-40/oz if the money supply had not changed. But to make it simple, we will assume it only increased 2- to 3-fold. 65 is a good number. So $65-$5 = $60 profit per ounce. SLW will produce approximately 32-35M oz. So $60*$30M = $1.8 billion. If the company has a current market cap of around $2.4 billion and should make at least a billion dollars (to be conservative) over the next decade, then wow! Of course I expect $65/oz to be the peak as was $50/oz in the 70's. More important is the long term silver price, which I think will be at least $20/oz, likely in the $22-$28/oz range.

Below is a published DCF valuation using conservative inputs. It is open for editing as I published via Google docs. A 5-8% discount rate is appropriate in my opinion because it is a royalty company with a diverse portfolio of silver streams, whereas if it did actual mining, 13-18% would be appropriate.

View SLW's valuation here.

Disclosure: Long Silver Wheaton