Silver prices are still hovering near record highs in anticipation of the release of a silver exchange-traded fund. But analysts say investors looking to strike it big shouldn't abandon silver mining stocks if the new ETF starts trading.

Silver was trading at just under $10 an ounce last week, down from the two-decade high of $10.26 reached earlier this month on speculation that the silver ETF proposed by Barclays Global Investors would soon be available to the public. The ETF hasn't gained regulatory approval to date, but the Securities and Exchange Commission recently closed its 21-day public comment period on the fund.

BGI is applying to list 13 million shares backed by 129 million ounces of silver in a arrangement similar to the pair of existing gold ETFs, the StreetTracks Gold Trust ( GLD) and BGI's own iShares Comex Gold Trust ( IAU). Under this structure, the precious metal is tucked away in a vault while investors buy and sell shares that each represent about 10 ounces of silver.

Since 129 million ounces equates to roughly 16% of the world's annual silver production and 21% of the known above-ground inventories of silver, according to investment bank Salman Partners, the ETF potentially could drive up silver prices more than it has already, perhaps even squeezing the market. As a result, the ETF has come under attack by the Silver Users Association, a trade group that lobbies on behalf of silver producers and distributors. The group says the proposed ETF "could make silver illiquid" and lead to manufacturing job losses.

Salman Partners recently raised its forecast for silver prices in 2007 to $11 an ounce from $7.75 on account of the new ETF's impending introduction, and the firm says prices could top $12 over the next two years.

The SUA may be worried about prices skyrocketing to dangerous levels, but investors in silver mining stocks have been giddy about all the attention silver has been receiving. Shares of silver miners have spiked since mid-January, when movement on the ETF was reported, and in most cases the stocks rose more than the metal itself because of the leverage associated in owning the miner instead of the metal.

"Silver companies have not been profitable for a long time, so marginal projects, if managed correctly, can turn into huge cash flow if prices stay high," says Rodney Stevens, a mining analyst at Salman Partners.

For example, Stevens estimates a beta-to-silver on the shares of Vancouver-based Silver Standard Resources ( SSRI) of 1.3 times. In other words, if silver prices go up 10%, Silver Standard shares will rise 13%.

Stevens rates Silver Standard a speculative buy and says the company's Pirquitas property in Argentina could provide a significant impact if it reaches its potential to produce 11 million ounces of silver per year.

Fool's Silver

One might think the prospect of increased leverage would entice those racy hedge fund investors, but Les Childress, a mining analyst at JM Dutton & Associates, says that in the case of gold, institutional investors have gravitated toward the ETF instead of individual mining companies.

The average daily volume of the GLD has risen to 4.7 million shares a day, mostly as a result of increased demand by hedge funds, mutual funds and other institutions.

"There are still a lot of sketchy mining companies out there and some bad memories of getting burned by fraudulent companies in the past, most notably the Bre-X fiasco," says Dutton. "ETFs remove that worry, because you are just buying the metal."

Dutton is referring to the 1997 collapse of Calgary-based miner Bre-X. The company falsely asserted that its property in Indonesia contained up to 200 million ounces of gold. Bre-X's shares crashed and investors lost an estimated $4 billion.

"If you can get good research on a miner, then you can spot the undervaluation in the market and your returns can be outsized relative to the gold ETF," says Childress. "But if you believe that the metal's price is around 70% of the performance of the mining stock, and you don't have a good feel for the company's operations, then why take the risk on the individual security?"

Childress' top pick among silver producers is Silver Wheaton ( SLW), though he currently prefers gold miners such as Goldcorp ( GG) and Barrick Gold ( ABX) to silver miners in terms of risk vs. reward.

"Mining companies have learned the errors of their ways," says Childress. "So you can get pretty good leverage if you choose the right stock."

On the topic of leverage, Michael Curran, a mining analyst at RBC Capital Markets, puts it another way.

"A mining company is always exploring so they can grow the reserve base behind each share," he says. "But the value behind a share of an ETF will be tied to what you own in that vault."

Curran's top pick is Idaho-based Hecla Mining ( HL), which he says is cheap at 1.3 times net asset value (or the discounted value of all the gold and silver in the company's properties), vs. 2 times NAV for the rest of the silver mining industry.

But for investors who are focused on owning the metal, it's still a waiting game for the silver ETF bells to ring.

As originally published, this story contained an error. Please see Corrections and Clarifications.

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