Analysis: Scrap silver rush strains refiners

NEW YORK (Reuters) - In a small Ohio town Bill LeRoy is running his plant around the clock and still can't keep up. While much of industrial America is still struggling to emerge from recession, LeRoy's waiting list has doubled in six months and he's turning away customers.

The frenzy at his company, Ohio Precious Metals LLC, is a reflection of the explosive rally in silver prices. One of four major U.S. silver refiners and among only 50 worldwide, the firm is racing to process scrap silver flooding the market.

From consumers unloading flatware uncovered in dusty attics to industrial dealers in photographic solution and film, a more than two-fold surge in silver prices over the past eight months is fueling a rush to sell every last scrap of silver.

Eventually, as LeRoy and others expand their capacity, the recycling of record sums of silver scrap may help contain a rally that has rivaled the massive Hunt Brothers price squeeze of 1980, when merchants recall being overwhelmed with people looking to sell their old flatware or unloved wedding gifts.

Until then, however, LeRoy's refinery in Jackson, Ohio about 100 miles east of Cincinnati is part of the problem -- the bottleneck in processing scrap is contributing to the tightest spot market supplies in decades. Investors and speculators are stockpiling a growing share of global supply via new silver exchange-traded funds and bullion coins.

"We get calls everyday from people asking for refining quotes, and we just have to politely decline at this point in order to support existing customers," LeRoy told Reuters. He's rationing services after his backlog doubled from late 2010.

For example, one single coin dealer brought more than 200,000 ounces of silver in March, he said. OPM typically receives half its silver in coins and jewelry products and the other half industrial scrap and sterling silverware.

LeRoy revved up his refinery to run 24 hours a day, seven days a week since January, processing everything from coins, flatware, old photography solution and electronics into near-pure silver grain and 100-ounce bars that are shipped in security canvas bags and crates to investors nationwide.

Even that's not enough. LeRoy is now in the process of doubling its silver refining capacity by June. He declined to disclose details on OPM's output for security reasons.

"Volumes of silver scrap are the highest we have ever seen in this industry. It's much more busier today than the Hunt Brothers period as there is more silver in the world out there today than it was then," LeRoy said.

PHYSICAL SQUEEZE

The price of silver has increased six-fold to $49.51 last Thursday from just over $8 in late 2008, eclipsing the peak set in January 1980, when Texas brothers William Herbert and Nelson Bunker Hunt sought to corner the market. Gold prices only doubled during the same period.

Silver has since retreated to around $38 on Thursday after futures margins were raised by 84 percent in just eight days.

While gold led the rally initially, silver has taken over since August, when the Federal Reserve signaled new easing measures and investors scrambled for hedges against a dollar decline. The white metal rose more than 110 percent versus gold's 25 percent gains.

While there's little debate over whether speculative fervor has fueled much of the gains, investor demand has also created a very real squeeze on physical supply.

Warehouse stocks stored against the silver futures contract traded on COMEX, now owned by the CME (CME.O), has tumbled to a four-year low, while lending rates are near their highest in two years. The market is also trading in a rare backwardation, making prompt prices more expensive than longer-dated ones.

The supply of silver from scrap sources should rise this year to a record, making up more than a fifth of the world's overall supply, after a 15 percent jump in 2010, the biggest gain in 10 years, said precious metals research firm GFMS Ltd.

Importantly, it is the one source that can respond most quickly to prices; it's far more difficult for miners to begin suddenly producing more. At the moment, however, supply from consumers and industrial recyclers is far outpacing the refining industry's ability to turn it into salable silver.

Some are ready to sell at a discount just to cash in quick.

"A lot of people who are selling silver are willing to take a haircut to get paid faster," said Miguel Perez-Santalla, vice president at Heraeus Precious Metals Management, part of a German group that specializes in metal manufacturing and refining.

BURNING DOWN X-RAY FILM

The flow of scrap silver supply is far smaller than for gold due to the very different pay-off -- an ounce of gold is still worth 40 times as much as an ounce of silver.

And extracting silver from things like old photographic fixer solution and bonding alloy used in electronic equipment is much more time consuming.

And while the surge in scrap supply in silver is only just beginning, it could be shorter-lived.

Supply from recycled silver was at a 10-year high at 215 million ounces (6,687.2 tons) in 2010, about one-fifth of global supply after mine production. However, scrap has grown just over 10 percent in the past 10 years,

Old silver scrap will certainly rise to a record in 2011 in the high-single-digit percent, said Philip Klapwijk, executive chairman of GFMS. However, the supply of recycled silver is less price-sensitive than that of gold, he said, and it is in structural downturn.

"Bear in mind that the bulk of silver scrap traditionally is from photography such as X-ray film and fixer solution, which are on trend decline due to lower demand," Klapwijk said.

Individuals can extract silver-rich ash by burning X-ray films. Refiners in turn convert these high-grade substance into pure silver using electroplating, an electrochemical process which is much more effective than burning.

WEDDING SILVERWARE FOR CASH

Heightened public attention has translated into a rush of consumers looking to sell off supply, with "cash for silver" signs now juxtaposed with those seeking gold.

"On Saturdays, we have people lining up outside the door to sell," said Craig Sklar, owner of Ridgewood Coin & Stamp Gallery in New Jersey, where he's bought everything from coffee trays to childhood coin collections and 1960s sterling jewelry. There's a cleaning out the attic feel: One couple sold "silver plates their parents bought as wedding presents."

Sklar said that the volume of traffic at his store is heading back toward the Hunt Brothers high in 1980, when he had to temporarily shut down. "Then, the refineries were giving checks to dealers postdated to the next week's date," reflecting the backlog, he said.

Soaring silver prices are also driving Indians to recycle jewelry into bars as an easier way to invest, a trend that will limit imports of the metal in the world's fourth largest consumer. India's silver scrap has risen nearly threefold in 2010 from that of the 2001, GFMS data showed.

More jewelers are beginning to buy back silver but there is roughly one in 10 is willing to take silver compared to stores buying gold, said Robert Headley, chief operating officer of Jewelers of America, a trade group comprised of 3,800 jewelry retailers.

"But that may certainly change if silver remains at $41 plus dollars," he said.

Jewelers typically offer buyback as a service and a way to bring in customers. They usually ship their customers' old or broken jewelry to refiners for cash.

Eric Harris, co-owner of Niletti Creations, which sells jewelry in New York's "diamond district," on West 47th Street, said that refiners have in the past given him bulk value for a big tray of silver jewelry he collected from his customers.

"Now, scrap silver is being treated as gold," Harris said.

(Editing by Cynthia Osterman and Alden Bentley)