Sliding COMEX inventory levels, strong silver demand and lacklustre base metal production expectations all suggest that the silver supply/demand balance should tighten materially in 2010/11-the key reason behind BMO Research's hypothesis that silver is likely to outperform gold.

Similar to gold, silver is considered quasi-money and a store of value. However, it is also very much an industrial metal, with almost 55% used in industrial applications. As such, it has benefited much more than gold from the improvement in the global economic environment over the last 12 months. Conversely, silver is currently being punished as the world worries about lower Chinese liquidity levels and the impact that may have on industrial activity.

Silver's store of value properties should partially shield it from the current de-risking-inspired correction and it is this characteristic that should make it a strong performer into 2011.

Silver's heavy weighting towards the industrial side has convinced investors that it will significantly benefit from the sharper-than-expected global recovery. Tightening physical fundamentals are projected to play an increasing significant role in setting silver prices. The sector is projected to operate near capacity, which is consistent with US$18-20/oz marginal cost of production.

Remember, traders were somewhat indifferent to silver when the world economy was moving into a deep trough. Markets were punishing it for being heavily used in manufacturing on the one hand, and rewarded it for being a hedge, monetary asset and a gold-like store of value used in turbulent times on the other hand.

Recent correction notwithstanding, the demand side has turned bullish and should be largely supportive of silver prices, while the impetus to hold physical silver as a hedge against inflation and potential U.S. dollar declines remains largely intact. Massive US deficits raise the spectre of debt monetization, which would likely cause inflation and place downside pressure on the U.S. dollar over the long term.

Silver is still cheap relative to gold, with the gold/silver ratio at around 67. In a bull gold market, this ratio should follow historic trends and narrow. A ratio of 57 is projected for 2010.

A more robust industrial demand side is all that is needed for a tighter ratio. This appears to be materializing with the global economy and industrial activity rebounding sharply. As such, BMO Research expects that higher silver prices are very likely to occur this year.

David Fuller's view There is far more useful information in BMO's Silver Book than most of us could absorb in a week's study, which is why I recommend setting it aside with other important reference works. Among quick impressions, the report reminded me that mega-miner BHP Billiton (one of my top-10 personal holdings by weighting) is actually the world's largest silver producer, although mainly as a by-product from other mining. However BMO expect London-listed Fresnillo (FRES LN), the largest primary silver producer, to exceed BHP's production by 2015. Aggressive investors will like the data on junior miners.

Historically, high-beta silver (has usually outperformed gold on the upside, although that has not been the case following the 2008 meltdown. Also, my own confidence in silver (p&f, monthly, weekly & daily) has been dented by its sharp correction commencing in the second half of January as resistance was encountered beneath the yearend peak.

Nevertheless, I think that precious metals remain in a secular bull market which began 10 years ago and can be summarised by: supply inelasticity meets rising demand. They also remain in a favourable seasonable period although this usually ends between March and May. However, there are certainly reasons for believing that this is not a usual economic cycle and this may affect trends, not least in terms of volatility.

I have also mentioned that with 'hard money' investment being a greater influence on precious metals than we have seen for a very long time, the correlation with equities is likely to remain relatively high more often than not. Therefore, if silver, gold (weekly & daily), platinum (weekly & daily) and palladium (weekly & daily) are to resume their uptrends over the next few months, I think we will need to see steady stock markets and a weaker US dollar. The precious metals will also need to establish a series of higher reaction lows above their early February troughs. Conversely, if the lows seen earlier this month are taken out, it will be this year's downtrend sequence of lower or approximately equal reaction highs that will be re-enforced.