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Gold Bug vs. Silver Bull: North vs. Sanders. You Pays Your Money and You Takes Your Chances.

Gary North
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February 9, 2006

My free newsletter, Gary North's Tip of the Week, usually runs half a page. It's not like this report. I'll bet you would like it. The subscription box is here: www.garynorth.com

I wrote a column on silver and gold as investments. It is on-line here:

http://www.lewrockwell.com/north/north436.html

Franklin Sanders has responded. He publishes The Moneychanger and sells coins.

My comments are in bold face.

Anyone who will read this debate is a true believer in hard money. But which hard money?

And remember: it's not hard money any longer. It's play-pretend hard money. Gold and silver are, for you and me, de-monetized. Sadly.


NEW, IMPROVED CONFUSION ON GOLD & SILVER

"The major monetary metal in history is silver, not gold." -- Milton Friedman

It is not a wise strategy to begin your case for silver by quoting the anti-gold standard economist who predicted in 1961 that if gold were severed from the dollar, gold might fall in price without the support it enjoyed from its connection to the dollar.

In his Feb. 2, 2006 lewrockwell.com article, "Buy Silver Or Gold?" Dr. Gary North answers, Don't buy silver -- or at least, don't buy much. With all due respect to Dr. North, his article was filled with rather large factual errors that lead to wrong conclusions.

This is an old debater's trick: at the begging of the debate, the debater asserts the existence of large factual errors in the opponent's case. If proven, this casts doubt on his opponents' case. The risk is that if the large errors turn out to be piffle -- marginal to his overall case -- the judges may conclude that the accuser was faking it.

Whatever my factual errors may be, they are nothing compared to the "facts" that led silver bulls to keep buying silver from 1980 at $50 an ounce to 1991 at $3.60 -- an investment catastrophe that wiped out more hard-money investors than any in history. This was a disaster that was promoted by silver salesmen with "factual" arguments . . . all the way down. That was the point of my article. The silver bulls' arguments were catastrophically wrong. Yet they all added up to the same one we hear today: "There is a major shortage of silver looming." Caveat emptor.

Fact is, over the life of the present precious metals bull market silver promises a much greater return than gold, say, 400%. What's more, unless your investment strategy is "dipped in cement," you will shun Dr. North's idea of "core holdings." Rather, you will pile up as many ounces as you can by swapping back and forth from gold to silver as often as you can.

First, this presumes that you can consistently beat the market. You can't. Second, even if you do beat the market, the IRS will tax you on your gains. Because short-term trades do not benefit from capital gains preference rates, you will be taxed at ordinary income rates -- your highest bracket. Then the state income tax will take its bite. Never forget this aphorism: "Win, and the government wins with you. Lose, and you lose alone."


IT HAPPENED WHEN?

Dr. North writes, "In June, 1963, the government passed legislation severing the legal connection between silver certificates and silver." This is an error. That legislation was not passed until June, 1967, allowing a year for holders to redeem circulating certificates in silver.

Well, now. Here is the first of my "rather large factual errors." Let us examine the magnitude of this error.

On June 4, 1963, Congress abolished the silver certificate. Any history of the silver certificate informs us of this. I shall quote from the article on "Silver Certificate" in Wikipedia: "Silver Certificates were abolished by Congress on June 4, 1963 and all redemption in silver ceased on June 24, 1968." Ron Pfister's currency site says basically the same. "Silver Certificate legislation was abolished by Congressional Act June 4, 1963 and all redemption in silver was halted in June 24, 1968." I read about this in the newspaper on June 5. As I said in my original article, I immediately recognized that Professor Sennholz's prediction the previous summer was correct: Gresham's law would drive silver coins out of circulation.

Why did I conclude this? Because paper bills circulate for only about a year. With no new silver certificates coming into circulation after June 4, 1963, the old bills would be replaced by Federal Reserve Notes within a year. Unless specifically redeemed in silver, the legally mandatory convertibility of paper money into silver was at an end. I decided to buy silver coins with both hands, which I did all summer.

On the other hand, the shortage of silver coin was by 1963 already becoming obvious, thanks to the rise of coin-operated vending machines and the government's longstanding policy of selling silver at below-market prices. Throughout the Fifties the federal government created high silver demand by selling silver at a below market price, 90 cents. It was, by the way, also below the statutory $1.2929 price. The government began that period with history's largest silver hoard, over three billion ounces accumulated between 1933 and 1963, and over 2 billion left in 1959). Roosevelt's silver market manipulations had accumulated most of this. His ill-conceived and worse-executed scheme to raise the silver price wreaked havoc on the world market and finally forced China off the silver standard and into the Depression with the rest of the world. After World War II the government began feeding the huge silver hoard to silver users as a long term subsidy.

No argument here. Why should I argue? This is the case against silver vs. gold: the existence of a huge inventory of silver in the government's vaults. But this never slowed down the silver bulls from touting the imminent shortage of silver, from at least 1967 until today.


DEMONETIZATION

Dr. North contends that silver was demonetized in 1963, but in fact that happened nearly 100 years earlier, in 1873. Otherwise, the tricks the government pulled in 1963 would never have been possible.

I ask: What was the meaning of the de-monetization of silver? It was the legislative revocation of what had been a legal relationship between paper money -- silver certificates -- and silver. You could legally demand silver with a silver certificate. You could not legally demand it with a Federal Reserve note. Silver was effectively de-monetized by law on June 4, 1963, when silver certificates were abolished. Only for as long as they did not wear out -- a few months -- would people exchange them for silver coins. But you could do that without them, as I did. Why? Because silver coins were all there were above the nickel. You could write a check and get silver. But the fact was, after June 4, 1963, Congress could legally replace America's silver coinage with clad coins, with no threat of redemptions for silver by millions of holders of silver certificates. Silver certificates were collectors' items by the summer of 1964.

By 1934 both silver and gold were in a similar state of "demonetization." Governments had officially stopped using them as money, but the world -- those troublesome individual human beings -- still regarded them as money, as they do today. This regard waxes and wanes directly with public confidence in central bank fiat money. True, central banks still hold gold as "reserves," but in the same way housewives hold a toilet brush -- reluctantly and at long arm's length. Given the history of fiat money, and its performance in this century, it is hard for rational people not to conclude that fiat money is nearing the end of its spectacularly pernicious run. If it collapses altogether, then the dollar will disappear, and the elitists who run the US and its money supply will return to silver and gold -- but only after their fiat money has impoverished the rest of us.


WHEN DID SILVER BOTTOM?

Dr. North also writes, "[Silver] then fell for the next 23 years, bottoming at $4. 67 in January, 2003." My bewilderment disables me from guessing how Dr. North arrived at this price and date for silver's "bottom."

During the 1990s silver made a very long bowl-shaped bottom, a very reliable bottoming pattern. On 22 February 1991 silver hit its low, $3.59, and on 1 March 1993 posted a double bottom at 3.60. On 27 November 2001 it made one last visit back toward that level, closing at 4.065 (all are closing prices). Why Dr. North chose January 2003 and $4.67 as the "bottom" utterly mystifies me. The low close for January 2003 came at 4.765 on 14 January. From a technical standpoint the bottom came on 27 November 2001 at 4.065.

I admit it! He has caught me in an error. He would have been wise not to mention this. I had said that silver bottomed at $4.67 in January, 2003. That meant about a 90% fall in the nominal price of silver, 1980-2003. In real terms, this was a 94% decline due to the depreciation of the dollar. Now Mr. Sanders corrects me. No, no, no, he says. Silver actually collapsed to $3.60 by early 1991. My comment: this means that silver declined from $50 to $3.60 in eleven years. That is a nominal loss of $46, in round numbers. That is a decline of 93%. But wait! There's more! Using the Inflation Calculator on the Bureau of Labor Statistics' site, www.bls.gov, we learn that to buy a dollar's worth of goods in 1980 would have cost you $1.65 in 1991. That means the dollar had declined by about 40%. So, in real terms, silver was selling for $2.16. That was a decline of 96% in round numbers. This decline was catastrophic to anyone who bought a significant quantity of silver in January, 1980, and held it to February, 1991. The magnitude of this loss dwarfs the decline of the NASDAQ, 2000 to 2001.

My point in my essay was simple: Silver coin salesmen were selling bags of silver coins all the way down. Most of them told buyers that there was an imminent shortage of silver. There wasn't.


A FAILED INVESTMENT?

Dr. North writes, "Gold is perceived as a money metal that is used by central banks. It is used by Asians as an inflation hedge. Silver has lost that perceived value. So, silver is more volatile. There was nothing to prevent its fall after 1980."

Silver fell by 96% in nominal terms before it recovered after 1991 to $4.67 in 2003. Gold fell at its worst from $850 in 1980 to $255 in March, 2001. That is a nominal loss of about 70%. In purchaing power terms, the loss was about 85%. That was what I said in my article. Which loss would you rather have had? Where was your money safest for over two decades, in gold or silver? In fact, both metals performed miserably. But silver lost more, faster. It was more volatile.

So silver is dead as an inflation hedge? Among Asians? Maybe Dr. North ought to inform those millions of Indian farmers who still store most of their wealth in silver.

When rhetoric replaces both logic and facts, the debater is losing the debate. I never said that silver is not an inflation hedge. What I said -- what the article was about -- is that silver will be a much bigger loser in a recession. It is more volatile because central banks do not buy it. As I said, in some 12-month periods, silver or gold may appreciate more than the other. It's the downside risk that is silver's Achilles heel.

On Dr. North's statement hangs all our investment strategy. If it is true that the world has turned it back on silver as an inflation hedge -- or, better stated, as "money" -- then we ought to shun silver for gold. But if this statement is false, we ought to buy both and form a bimetallic strategy that leverages both metals' strengths in our favor. (Remember that I call "monetary demand" demand for silver as silver, which some call "investment demand.") Besides, Dr. North's statement is also false historically.

My article said to buy both. Again, when rhetoric replaces facts and logic, the debater is losing the argument.

Look at silver's history from 1873 to 1980. Once U.S. demonetized silver in 1873, followed closely by Germany, then huge monetary demand was removed from silver and its price entered a long decline. The gold/silver ratio (the number of ounces of silver required to buy one ounce of gold) rose (remember, silver is becoming cheaper against gold, so it takes more silver ounces to buy a gold ounce). By 1914 it had climbed from 16:1 to 41.19:1. During World War I Indian monetary demand kicked in, dragging the ratio down to 15.49 in 1919. From there silver entered a long decline (monetary demand was shrinking) until the ratio peaked at 100:1 in 1941.

This is historical filler. It is utterly irrelevant to what happened after 1962. My article began with my course from Sennholz in 1962.

After a long period of government-fixed prices, monetary demand revved up again in the early 1960s. Even Dr. North himself confesses that he was driven by monetary demand for silver in 1963.

"Even" Dr. North? I was buying silver before Sanders was. I was selling it for a living at Monex in 1973. Folks, I am one of the old-timers in this business -- a mostly losing business for investors for over 40 years.

Which brings us to the one key necessary to understanding silver and gold: It is not industrial but monetary demand that drives the price of silver and gold crazy. Once you understand that, you'll stop worrying about the silly yearly supply demand surveys.

I worry about future supply and demand when I buy an investment. So should you.

According to Dr. North, "There was nothing to prevent [silver's] fall after 1980." Of course not. Fed chairman Iron Paul Volcker screwed interest rates up to 25% trying to suck monetary demand away from metals, so silver's price fell. Does that surprise anyone? Matter of fact, gold's price fell, too, from the same cause. From its 1980 peak to its 1991 bear market low, silver lost 93%. From gold's 1980 peak at $850 to its bear market low of 253.70 in August 1999, gold lost 70%. Since bear markets generally lose 50% to 95% of their foregoing bull market peak, both these are merely normal performances.

My point is this: Anyone who sold silver coins should have seen this coming. No one in the hard money camp did. The silver bulls used one argument above all others: "Silver is running out, Real Soon Now." It wasn't.


IS THE SUPPLY GAP ARGUMENT FALSE, TOO?

Dr. North writes, "For almost the entire 23 years of its price decline, there were bullish silver brokers who kept talking about the huge gap between low silver production and high silver consumption. Here is my question: If that argument led to losses for 23 years, why should anyone believe the same argument today? There was a negative correlation for most of those 23 years between that argument and the price of silver."

Zoot alors! Again, this is very strange. Dr. North has the period all wrong. Nobody has been claiming a supply shortfall for 23 years (1980-2003?), but only since 1989. The years before 1989 were surplus years when more silver came to market than fabrication consumed.

Oh, yeah? For all you buyers of silver out there, who lost your shirts, let me ask you: Why did you buy silver? Wasn't it because the silver bulls, but especially Jerome Smith, told you that silver was running out? Coin dealer Jim Cook has recently summarized Smith's arguments. The main one was that there was a looming shortage of silver in relation to demand. Smith made that case in 1980. How valuable was Smith's advice after 1979? I just checked Amazon. Someone will sell you a copy of Smith's book, Silver Profits in the 80s, for six cents.

At least, they showed that way in "official figures" until the "officials" changed the figures. Truth to tell, there aren't any "official" figures, only figures from Gold Fields Mineral Services (GFMS) and CPM. Until 1995, when GFMS took over, CPM Group compiled the yearly World Silver Survey for the Silver Institute. Contrary to Dr. North's implication, the numbers for the entire series of years change very much from yearly survey to yearly survey, enough lately to render them ridiculous and just about worthless. By the very nature of that survey, the "figures" can never be more than sophisticated guesses, interpolations, and inferences. And in all fairness, the world silver market is far too vast and diverse for anyone to track each & every transaction.

So all the figures available for silver supply and usage are very unofficial. Fixing those numbers is like shooting skeet off the back of a bass boat in a thunderstorm. What makes the figures even more baffling is that GFMS revises them all every year.

In my essay, I said that until someone shows you verifiable statistical evidence that shows where the never-forcasted but always available above-ground supplies of silver have come from since 1965, don't take seriously the argument that the world is running out of silver. That argument has been wrong for a generation.

Mr. Sanders responds with an odd argument: there are no reliable statistics. My point exactly. I ask: Why should anyone take seriously the ever-present forecast of an imminent silver shortage? It has been wrong for a generation.

The price statistics reveal, decade after decade, that the supplies are plentiful. This is reflected in silver's price. It has not gone up in a big way except for 1979, when Bunker Hunt tried to corner the world's silver supply through the futures market, an adventure that cost him several billion dollars in losses in 1980.

The argument that there is a looming silver shortage boils down to that most familiar of slogans, "This time it's different!" Maybe it is. Ask for proof.

Roughly, here's what has been happening with silver supply and demand. About 1989 supply began to fall short of fabrication demand, resulting in a "structural deficit" (fabrication demand greater than mine supply and recycled scrap). That shortfall has persisted ever since. Depending on which yearly survey's figures you take, the shortfall averaged 100 million ounces (moz) per year for a total of 1,515 moz 1989-2004. The shortfall has ranged from 1.9% of silver used in fabrication (1989) to 20.2% (1994), or about 12% of yearly fabrication demand. (Using the 2004 figures, which GFMS jimmied and jived considerably from the 2003 figures.)

These shortfall figures may jump and vary, but the inference remains that about 1.5 billion ounces of silver was burned up from 1989 through 2004.

How then (Dr. North asks indignantly) could silver's price remain so low in face of that demand pressure? Simple. About one billion ounces excess to demand had come to market from 1980 through 1989. That excess had to be worked off before the price could rise. Now that has happened. One billion ounces excess less one and a half billion ounces shortfall leaves half a billion ounces shortfall -- more or less.

OK, all you silver investors, 1980-1989, why didn't your silver coin dealer tell you about this extra billion ounces of silver that were overhanging the market? Why did he believe that the world was running out of silver? The time to discover the extra 100 million or 200 million extra ounces a year is not after the price of silver has fallen again, but before. The seller should say: "Don't buy silver this year; there is plenty of above-ground supply." Most relevant, why should we believe the same argument this time? It's like Charlie Brown running to kick that football. Lucy pulled it away every year for a generation. He never learned. Neither do silver bulls.

Two observations are needed here. Dr. North may not see any plausible explanation for silver's long price lethargy while facing such a shortfall, but in fact traders know that commodity shortfalls can persist for long periods without price adjustments. Oh, the price always adjusts eventually, but not with mechanically predictable precision. It's a market, and markets are made of humans, and humans are mysterious. Besides, we can never exhaustively know all the factors in any market.

Invest in gold rather than silver until some silver bull can show that he can predict next year's supply/demand statistics and the price of silver. Until this happens, you are buying futures in the Church of Silver. I invite you to buy futures in the Church of Gold. You are dealing with True Believers -- disbelievers in the ethics or wisdom of modern banking.

Second, commodity demand does not drive the prices of gold and silver. Write this in your book, yea, grave it upon your walls.

Both silver and gold are "industrial metals" in the sense that both have some uses that are not monetary. But industrial demand and supply change only slowly over time. The price of gold won't shoot up 25% in one year because gold jewelry suddenly becomes fashionable and women begin buying more necklaces. Rather, the real price mover for both metals is monetary demand that hits at the margin and changes suddenly and massively when confidence in fiat money wanes. Think of the way crowds move, swayed by fashions, rumors, and panics. The same humanity is what really moves silver and gold.


GOLD LEASING & THE CARRY TRADE

In the last 10 years or so gold's price has been most strongly influenced by the "gold carry trade." Through private bullion bank acting as middlemen, central banks have loaned gold at ridiculous rates, 1.5% and lower. Borrowers could borrow gold, sell it into the market, and invest the proceeds in risk-free government bonds paying 5% or more. Back up the truck: free money! And if this gold "carry trade" suppressed gold's price, well, the central bankers weren't crying, since they needed to do that to hide their inflation anyway. And although Dr. North seems unaware of it, at hands of the same bullion banks a silver carry trade has also flourished, only more so. If central banks actually hold all the gold they claim (32,000 metric tonnes) and roughly 800 moz of silver exists in Comex, Tocom, and European dealer stocks, then we can estimate that for every ounce of gold there is one ounce of silver. Plainly, there's not nearly as much silver as everybody thinks, and it is steadily being consumed.

"No central bank holds silver," says Dr. North. Right, and that's one of the greatest arguments in silver's favor, since it makes it harder for central banks to manipulate silver.

Conclusion: the collapse of silver, 1980 to 1991, was not the result of central bank manipulation. It was therefore due to silver's disastrous fundamentals. So, why didn't the silver bulls see it coming in 1980, 1985, or even 1990? Because silver bulls are True Believers in silver. They are not like commodity futures' traders, who make money on price moves and care nothing about the commodity. They are True Believers who are committed to silver as a statement of principle -- the same way we gold bugs are committed to gold. But we gold bugs have a better track record -- merely terrible, but not catastrophic.

"Finally, if the bullion banks are ever asked to repay the gold, the gold bullion market faces a day of reckoning: massive buying by shorts (bullion banks) or else the widespread awareness that central banks do not have as much gold to sell off to keep down its price. Both events would drive up the price of gold. There is no comparable upward pressure for silver."

Dr. North errs. There has been a massive silver carry trade. The massive short covering rally that will hit gold thanks to the carry trade will hit silver just as hard, or harder. Only since silver is a smaller, thinner market, the short covering panic will drive silvers price farther and faster

My recommendation: Based on the carry trade argument, don't put your money on the line for silver vs. gold until you are sure that one of these carry trades will have a significantly greater effect upward on prices than the other. But silver carries the burden of proof because of the lack of information on the above-ground supplies -- an information gap that has consistently produced losses for silver investors for 40 years.


THE GOLD/SILVER RATIO: PHANTASMAL OR FAITHFUL?

"There was a close correlation [between silver and gold] for many decades: 15 to one. That was because this ratio was set by Federal law. It was a price control. Gresham's law always took over."

Dr. North has it upside down. It has been centuries, not decades. Before the 20th century, governments were setting a price by chasing the market. But let me start at the beginning.

Here we go: a romp through the history of the two metals since primitive times, millennia before silver was de-monetized, before the rise of the modern international gold standard. The relevant investment question is this: What has the ratio been since the rise of the post-Napoleonic industrial world? Second, what has it been since World War I? Anyone who invested in terms of an alleged ratio anything like 15-to-one lost his shirt. If an alleged ratio produces investment losses for a century, find a new ratio. Find an explanation for this new ratio. Then prove that someone can consistently make money using it. Show me the money!

Since memory runneth not to the contrary and as history records, there has always been a system of bimetallism using both metals as money. Bimetallism enables both metals to be valued by an independent yardstick: the other metal. In early Egyptian times (3200 BC) it took as little as 2.5 ounces of silver to buy an ounce of gold, or as much as 10 ounces (1,000 B.C.). Until New World silver supplies began pouring out after 1492, the ratio ranged from 7.5:1 to 12:1. In 1497 the Spanish mint ratio was fixed at 13-1/3:1. By 1641 it had climbed to 14:1, then 16:1 in 1690. By 1785 it was 15:1 in France, 15.5 in Great Britain, and 16:1 in Spain.

Soon, your eyes will soon glaze over. Let me summarize the facts presented: There is no predictable gold/silver ratio when government price controls are removed, as they have been.

With deliberate purpose in 1792 the newly formed US government set its gold silver ratio at 15:1 lower than the world market, to draw silver into the country. The lawmakers viewed silver as the more useful of the two metals, since it was the metal mostly used in domestic trade, while gold was used chiefly in international trade. The first US congress by the Coinage Act set the ratio at 15:1.

This was a government price control.

But rather than skewer themselves on a fixed price scheme, they set up a symmetallic system where silver was the country's official money, with supplementary gold coins valued in silver. From time to time the gold coins' size could be raised or lowered according to changes in the world market ratio, while the silver coin remained unchanged. (This was actually done in 1834, without cheating a single person, but that's another story.)

Plainly, from 1500 to 1873, government "price fixing" kept on chasing rather than setting the market. Adding New World silver to world supply raised the ratio (lowered the silver value against gold) nearer to the natural occurrence ratio. (In the earth's crust is found about 17 times as much silver as gold.) Any ratio movements from 1941 through 1963 are virtually meaningless since government fixed the gold price and the US government was selling silver out of history's biggest stockpile. Only after gold's price began to move in the London market and the US silver market re-opened in 1963 (Roosevelt had suppressed it in 1934) does the ratio begin to resemble a market-determined price.

Then we find that in a bull market the ratio sinks toward 16:1 and lower (14.59 in 1967). Hey, wait -- we already knew that from the World War I rally. That also took the ratio below 16:1 in 1919. In the 1980 bull market blow-off the ratio sank again beneath 16:1.

There is no predictable ratio when there is no artificial price control and no gold redeemability by governments. When there is a fixed ratio, one or the other of the two metals goes out of common circulation: Gresham's Law in action..

So how can we understand Dr. North's categorical assertion, "[T]he gold/silver ratio as a forecasting tool produced only losses, 1980 to 2003." Could any statement fly more squarely in the face of the facts? I know of no single market forecasting tool (other than the equally reliable Dow Jones Industrial Average measured in gold dollars) that more accurately forecasts the primary trend. Without the ratio dropping, there is no bull market in metals; without the ratio rising, no bear market. Period. Like every other market or indicator, the ratio zigs and zags, and on any particular day in a 20 year bull market, the ratio might drop. Its long term trend, however, will solidly follow -- indeed, point out -- the metals' primary trend.

There was no such 15-to-one ratio or anything remotely like it in modern times. He who bought silver rather than gold lost money for a century. A word to the wise is sufficient.

The ratio topped in 1914 at 41.16 and bottomed below 16:1 in 1919. From there it rose to 100:1 in 1941, then fell until it touched below 16:1 again in 1967. Climbing to 47 in 1973, it then dropped below 16:1 again in 1980. Silver fell from 1980 until the ratio hit 100:1 again in 1991, and dropped to 40:1 in 1998. It climbed from there until June 2003, topping at 82, and has since dropped to around 58 today.

Putting it bluntly, there ain't no predictable ratio! Get over it, ratio guys. The alleged silver-gold ratio is the phlogistan theory of the hard-money investment world. There are prices that change in relation to each other with no predictable long-run pattern. If there were such a predictable ratio, and if you could forecast it, you could make a fortune in the commodity futures market, where you can get leverage. You would surely not buy and sell precious metal coins, where you get taxed to death and have to tell the I.R.S. that you own physical gold that you are swapping back and forth.

When any commodity returns to the same levels two, three, or four times during 100 years' trading, I begin to suspect a pattern. And while past performance is no guarantee of future, a reasonable man would bet that from 1991's 100:1 we are headed toward 16:1 before this bull market ends, say, 10 years from now. If gold reaches $1,250 (a modest target only 5 times its bear market low) and returns to a gold/silver ratio of 16:1, silver would reach 78.80. In other words, it would outperform gold 400%.

I beg


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