Nice knives you have been posting, Neutron.
For buffing wood, there are some "rules" to know...
Yes, the grey stuff is normal. It is metallic gunk mixed with the compound, leaving a grey or black residue. You can remove some of it using a paper towel wet down with laquer thinner. The only other way is to sand down below the bottom of the open grain, removing the outer layer of wood until the stuff is gone. Then don't use the buffer again on this handle.
I only buff woods that:
1)Have a very tight grain, and the pores are small enough to not trap the buffing residue (desert ironwood)
2)Very dark woods that are hard, can be buffed, and won't show the residue (ebony)
3) Stabilized woods, because their grain and pores are filled with polymer stabilizer (this applies also to dymondwood and actionwood)
4)woods that have the grain completely filled with epoxy, sealer, super glue, or other finish.
Maybe someone has something else to offer.
Woods that don't fit the categories above, are usually better off finished by hand sanding, then apply a finish by hand. My favorite is Fornby's Tung Oil. But there are a bunch of others that work well.
Buffing works well on bone, antler, horn, and synthetics like G10, micarta, and phenolic. Of course, buffing leaves the same crap on bone or antler if there is any "bark" or inner pith showing.
Staining should be done before any finishing, including buffing and applying a finish.
Larger wheels simply get more speed at the outer edge, given the motor speed is the same. I like larger wheels because they fit the hollow grind that I usually put on a blade (I grind with 8" wheel, and buff with 8" wheel). other than that, bigger is not necessarily better.
Dan