Sneaky COMEX Rule Changes

July 9, 2020

By Patrick A. Heller

The COMEX began trading gold futures contracts shortly after it was again legal for Americans to own gold at the beginning of 1975. An explicit purpose for setting up this gold exchange was to help manage the price of gold.

By the fall of 1976, the price of gold had been pushed down from close to $200 per ounce to just over $100. As most readers know, gold then went on a tear, eventually peaking over $800 in January 1980.

Over the decades, the COMEX has implemented rules changes that had the effect of restraining gold prices. Here are a few examples.

When gold was peaking in 1980, the COMEX added a rule that prohibited anyone who owned a contract from selling it to any party except the brokerage firms who were trying to cover their short positions. Since the short sellers were aware of this rule, they reduced their bids, a move that helped end the rise in gold prices.

The COMEX either raises or lowers the margin requirements for long and short traders who use leverage in their trading. If investors are buying contracts on margin, they might be forced to liquidate if margin cash requirements are increased. This has the effect of stemming demand for such contracts at the same time that it increases contracts put up for sale.

Conversely, if the COMEX wants to encourage more short selling of contracts to halt rising prices or to push down prices, it can lower the margin requirements. This has occurred numerous times at key points in a market cycle.

Ever since it started trading gold futures contracts, the only kinds of gold inventory counted by the COMEX were physical bars in their bonded warehouses. These bars were classified as either “registered,” which meant that they were available to deliver against contracts, or they were “eligible,” which meant that they were not available to deliver against contracts. However, because they were already in a COMEX warehouse, these bars were eligible, at the option of the bars’ owners, to be reclassified as registered. Then, late last year, as a blatant attempt to bailout HSBC, the COMEX began to allow “pledged” gold as part of inventories in COMEX warehouses, even though no physical gold was actually there.

In March this year, when faced with a shortage of 100 ounce bars to deliver against maturing gold contracts, the COMEX added a new “Gold Enhanced Delivery” contract for 400 ounces which could be fulfilled by delivering any combination of kilogram, 100 ounce, or 400 ounce bars.

Also in March 2020, the COMEX created a new means of settling a maturing a 100 ounce gold contract called for delivery. Instead of delivering the bar, cash, shares in an exchange traded fund, or exchange for physical, the short sellers could deliver a new form of paper gold called “Accumulated Certificates of Exchange (ACE). These ACEs reflected partial ownership of a 400 ounce gold bar. In theory, someone could acquire four ACEs and turn them in to demand a 400 ounce gold bar. There was only one problem with that alternative because the COMEX had no 400 ounce gold bars in its warehouses at the time this option was established.

For almost the entire history of the COMEX gold contracts, the only bars that qualified for delivery against maturing contracts called for delivery where those fabricated by companies currently certified as meeting COMEX quality standards. In a sneaky move, the COMEX recently expanded the bars eligible to deliver against maturing contracts by declaring that bars with hallmarks of any fabricator who at any time had been approved for COMEX deliveries were acceptable. That means, for example, that bar brands such as Elemetal and Republic Metals, businesses no longer in operation, could be delivered. This rule change effectively increased the inventory in COMEX warehouses that qualified for delivery.

Over the decades that the COMEX has traded gold contracts, virtually every time there was a rule change, the net effect was to help hold down prices. As the price of gold reached its highest prices since September 2011 this week, don’t be surprised if the COMEX creates or changes rules to seek a similar result.