Silver prices rallied to their highest in 31 years on Monday and are fast closing in on $40 an ounce, lifted by interest in the metal as a cheaper proxy for gold and expectations that industrial demand is set to improve.

But analysts remain wary of silver's extreme volatility, which has led to some heart-stopping reversals in recent years.

When commodities sold off heavily in mid-March, it dropped nearly 5 percent in a single day, versus gold's 2 percent fall.

Silver prices have had an impressive run higher since the financial crisis gripped markets back in late 2008, rallying from below $9 an ounce in October that year to a 31-year peak of $38.40 on Monday.

Two Hats

Investors have flocked to the physical metal in recent years.

Like gold , silver proved extremely popular with buyers seeking a safe place to store wealth as insecurity swept the equity and foreign exchange markets.

Holdings of the largest silver-backed exchange-traded fund have risen by 65 percent since October 2008, while demand for silver coins in the United States soared to record levels in the first quarter of 2011.

In addition, silver has benefited from expectations industrial usage will rise.

The metal is widely used in electronics manufacturing.

Metals consultancy GFMS forecast last week industrial demand will climb by more than a third by 2015.

"Without a doubt silver has been having a role both as an industrial and a safe-haven metal, and that is why it's benefited," said Simon Weeks, head of precious metals at the Bank of Nova Scotia. "I don't think it's the single-digit commodity it was for many years. I don't think, given the overall industrial usage for silver and the overall supply picture, we are going to back to those kinds of numbers any time soon."

While some areas of industrial demand, such as photography, are in long-term decline, others are expected to pick up.

GFMS identifies its growing usage by carmakers and the solar energy sectors as key in years to come.

Silver is also used in small quantities in a range of consumer goods including water purification systems, plasters, and socks, demand for which is expected to pick up as the economic picture brightens.

Heart-Stopper

Silver's outperformance of bellwether precious metal gold is partly due to the much smaller size of the market.

A lack of liquidity tends to mean any price moves are exaggerated, leading to overperformance in a rising market but underperformance when prices fall.

"There is a huge amount of speculative drive behind silver, and that is off the back of gold," said Societe Generale analyst David Wilson. "It has such a head of steam it seems difficult to say it won't (keep going), but there doesn't seem to be that much of a reason for it to be as strong as it is."

A lot will depend on the broader investment environment for precious metals, chiefly reflected in gold prices.

Gold and silver are currently 85 percent positively correlated on a 30-day rolling basis.

While accommodative monetary policy, a fragile dollar and elevated risk aversion have benefited precious metals in recent years, any reversal in this environment could hurt gold prices and have a potentially devastating effect on silver.

A recent Reuters survey of analysts' gold price forecasts showed fewer than one in ten believed gold would end the second quarter more than 5 percent above current levels.

Given such relatively modest expectations, silver could be vulnerable.

Given the amount of silver held by ETFs, which is technically still available to the market, and comfortable mine output, the market is unlikely to be short of metal even though demand may rise.

Investment demand for silver has done well out of the financial crisis, but with the economic recovery and a consequent recovery of industrial consumption still in its early stages, this may reverse quickly if that buying tails off.

"When investor interest wanes in silver, there is every possibility of sharp falls in price amid liquidation and plentiful metal stocks," said RBS in a report.

"Equally, though, we must warn that because of its volatility, silver is too dangerous to short," it added. "The message is, do not chase silver at these levels."