What Is the COMEX and What Does It Have to Do with Gold and Silver?

Did you know that ownership of most of the gold and silver that are exchanged not as physical precious metals but as contracts on the COMEX? The COMEX is a shortened name for the Chicago Mercantile Exchange, otherwise known as the CME Group. The COMEX is where people make trades in the derivatives market, including in precious metals derivatives.

Key Takeaways

1. COMEX is the world's largest futures and options trading for metals.
2. It is a division of the Chicago Mercantile Exchange (CME) Group.
3. Metals futures are mostly used for hedging and are not typically delivered.
4. The COMEX does not supply metals but instead acts as an intermediary.

What Are Derivatives on the COMEX?

On the COMEX, gold and silver are traded through contracts called derivatives. The contract is based on the underlying asset, which is the precious metal. 

Where Is the Physical Gold?

The physical gold and silver are kept in COMEX-approved depositories, such as Brinks or Delaware Depository. The COMEX categorizes its precious metals as either eligible or registered. Here are some definitions you should know.

• Warrant: A document that gives you the right to buy or sell the gold or silver on the derivatives market.
• Eligible:The physical gold or silver is housed within the COMEX system but does not have a warrant. You can’t take delivery without a warrant.
• Registered: The physical gold is in the warehouse, with a warrant allowing you to take delivery if you choose to on or before the warrant expiration date.
• Pledged: A specific category of Registered. In this case, the precious metals have been pledged only and are not physically present in the warehouse.

How Do You Exchange Gold and Silver on Comex?

Rather than trading physical gold and silver, you trade the gold and silver using a paperwork system. You have a futures contract with a gold seller. Every month, the COMEX contract expires, but most investors simply take the loss or gain and renew the contract, also called “rolling.” .

If at any time, you decide you want to take possession of the gold, you can opt to have it delivered rather than rolling over the contract again. However, the gold must be registered, as described above.

Pros and Cons of Derivatives

Pros

Derivatives are more convenient for many people. You don’t have the physical labor or cost of transporting the gold every time you want to trade it. It’s a more efficient way of investing in gold and silver.

Cons

Derivatives come with some counterparty risk, meaning that the person you make the contract with could fail to live up to their obligations as set in the contract. This is especially true for pledged gold.

Increased Gold and Silver Deliveries May Affect Prices

Many people invest in gold futures for years before they take delivery, if they ever do. However, when more investors are taking delivery, the physical gold and silver markets can be affected, though there is rarely a direct effect. After all, when you’re trading physical gold rather than paper certificates, that gold is being taken out of circulation. What’s more, the seller must produce the actual gold. You’re no longer dealing in promises but you are taking possession of the asset.

Delivery, though, doesn’t usually mean that the gold comes to your house or even your own chosen storage facility. You can get physical delivery, but in most cases, the gold is simply moved to another part of the COMEX system.

Learning From History - Warren Buffett's Silver Supply Squeeze of 1998

In 1997, silver was trading around $4.50, a price Warren Buffett deemed exceptionally low. His company, Berkshire Hathaway, seized the opportunity, gradually accumulating COMEX silver contracts set to mature in March 1998.

Buffett's strategy was meticulous, aiming to mitigate the risk of price hikes working against him. By February 1998, Berkshire Hathaway's holdings amounted to a staggering 129 million ounces of silver.

In a bold move, Buffett declared his intention not to roll over the contracts but to demand physical delivery upon maturity—a demand that COMEX inventories couldn't meet. Short sellers found themselves in a frenzy, scrambling to procure physical silver to fulfill their obligations to Berkshire Hathaway.

The consequence? Silver prices surged to over $7.30 by mid-February, marking a remarkable 60% increase from the previous year. However, Buffett eventually relented, offering short sellers an extension on delivery in exchange for a premium rumored to be 50 cents per ounce.

Berkshire Hathaway eventually transferred its silver holdings to a silver exchange-traded fund, liquidating the entire position by 2006.

Following the resolution of the silver supply crunch, prices retreated, hovering below $6 and occasionally dipping below $5 for several years. It wasn't until early 2004 that silver prices surpassed their peak from February 1998.

Watch this video from Warren Buffet and Charlie Munger...

What Happens if there is another Silver Squeeze?

The U.S. government, particularly sensitive to precious metal price shifts due to their impact on the dollar's value, would likely take measures to prevent a silver surge. This could involve pressuring allied central banks and financial institutions to suppress silver prices.

Additionally, the government might coordinate with entities like JPMorgan Chase to utilize their silver reserves, possibly borrowing silver or even reallocating it without explicit consent.

Even if a squeeze is averted, the repercussions would differ from the past. The need to return physical silver would sustain a shortage, fueling ongoing demand from both manufacturers and investors.

In Summary

Irrespective of immediate developments, the enduring shortage of silver for manufacturing demands, particularly in regions like China, will continue exerting upward pressure on prices. This dynamic could also spur increased demand for gold, contributing to its price rise.

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