COMEX Default?

I was recently asked what would happen if the COMEX "crashed," I assumed that he basically meant, what would happen if the COMEX "defaulted."

The COMEX would potentially "default" if the short, the broker or the COMEX could not deliver silver. Before this would happen you should see the futures market enter a period of backwardation and margin hikes. Well the market is in backwardation and CME, MF global and now Think or Swim (geared more towards retail investors) have recently hiked their margin requirements, not meaning the COMEX will default very soon but that the environment for an event like that is present if investment demand remains constant or increases going forward 2-3 years.



You see if I as a short futures holder have the obligation to deliver silver to my corresponding long if the long wants 5,000oz physical per contract. If you as the short holder cannot make good, your broker must make good delivery bars available to the long, if the broker cannot do this the COMEX has to have the silver to deliver to each standard long contract. If the COMEX cannot deliver you would have to settle in cash, at which point you would have a default of the contract (future) as the legal agreement has been broken. If this was on a somewhat large scale (COMEX is short 50,000,000oz +) the price of silver would most certainly rally based on this, to what degree is uncertain of course.



Take into account when the LME (biggest base metals exchange in the world) defaulted on it's nickel contracts in 2006, the price rallied a little over 100%, while in a strong bull market at the time, other base metals lagged. The LME charged the short contact holders around 1% per day to the long contract holders until they could make good on them. So, there you have it, the COMEX could default on silver and the COMEX still be around in 20 years. The COMEX won't "crash," it has no price and it simply an arm of the NYMEX which was taken over by the CME Group. It would be a big event for silver and a sizable shift in the thinking of many other synthetic, leveraged holders. Contracts may be settled in cash, settled by deferred delivery with a penalty, trading would halt for a short period of time, they could close the exchange or a combination of the first three with a legal hangover that would last as long as the silver rally or longer if it is not handled properly.

As of April 27th the COMEX had 35,722,317oz of registered silver and 66,034,220oz eligible silver for a total of 101,756,537oz currently in warehouse stocks (worth around $4.5 billion) while the open interest (in silver) is worth over $32 billion. Rest assured it is typical for 1% of buyers to take delivery, allowing a fractional reserve of bullion traded to contracts traded. In other words, a relatively small number of holders could take delivery in a short amount of time and cause delays or possibly a default.