While industrial demand for silver remains firm, financial demand has caused prices of the metal to balloon to an excessive level, UBS says in a new report.

Silver reached an all-time high of US$49.80 per ounce this week, bringing the gold-to-silver price ratio to nearly 31 times. Silver has risen more than 150% year-over-year and nearly 50% year-to-date, outpacing other precious metals and real assets by a wide margin.

“While further advances in the short run cannot be ruled out, we do not expect current levels to be sustained…” UBS strategist Mark Bulsing told clients, warning that silver prices are prone to sharp price movements.

He thinks the current price bubble could last long enough to push silver to US$55, but sees the metal falling toward US$34 over the next 12 months.

Silver mine production contributed just 3% to total supply growth in 2010, and scrap supply, which accounts for 20% of total supply, is also largely indifferent to prices. As a result, Mr. Bulsing noted that the unusually large 5.5% contribution to total supply growth seen last year is unlikely to be repeated.

“To balance the market in 2011, this leaves the job to silver hedging activity by silver producers or to the demand side,” the strategist said.

There has been a significant increase in hedging activity as by-product producer began to lock in higher prices. This development should be repeated in 2011, “but it should not be enough to calm markets,” Mr. Bulsing said.

The only other option is to curb demand growth. However, he believes trend-following investment demand is unlikely to start cooling unless economic activity softens materially and industrial demand retreats.