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The Gold / Silver Ratio

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January 12, 2010 – Comments (22)

I have a series of posts going regarding important Gold ratios. This is the third installment.

1. Gold Miner Performance: A Look Miner Cost Inputs vs. Gold Price - Dec 30, 2009
2. Gold Miner Performance Relative to Gold - Jan 11, 2010
3. This Post - The GSR
4. The Dow/Gold Ratio - forthcoming. I have written several posts on the DGR in the past, I will update those based on recent developments
5. Other Gold Ratios - forthcoming. Again, I have written several posts on these that I will update.

The Gold / Silver Ratio (GSR) is another key ratio that describes larger market trends and perceptions, much like I showed with the HUI/Gold ratio in my last post. So lets first start off with a long term chart of the GSR.

ENLARGE

Like I pointed out in my last post, this is a chart of the Gold / Silver ratio. When a ratio is increasing, it means that the numerator is increasing faster than the denominator OR the numerator is not dropping as fast as the denominator. Outperformance means either moving up faster or not dropping as quickly. This is why I included Gold and Silver price history at the bottom of the chart so you can see the relative movement.

But first, let me talk a little bit about what Gold and Silver are.

Gold is sound money. Now you may be a gold bear, and think it is a useless shiny piece of ... metal. But the odds of someone of that mindset actually making it far down this post is probably unlikely. However, my point is, there are *many* people who feel this way, even if you don't happen to agree with them. And so it is important to understand what many other investors think. My $0.02, and take away from that what you want.

Gold is sound money, which means it represents safety. It is a safe haven move in times of crisis to go to physical gold or to funds that have claims on physical gold (there is a *very important* distinction to be made here about gold / gold funds / types of gold funds. But I have made them many times before and this is beyond the scope of this post).

Silver, however, is a different animal. Silver is another monetary metal, yet it has a very wide range of industrial uses. As such it straddles the line between a currency and a commodity. However Silver has some very interesting facts: For a long time it was not recycled (unlike gold which has been recycled for a long time in industrial applications). This is not true anymore, it is being recycled more now, but there are still many applications where it is not due to economic non-viability. As such, a large portion of silver is literally sitting in landfills in various chemical states. But because there is still so much industrial demand, the amount of silver sitting in vaults as a monetary metal is lower than the amount of gold. This makes Silver a bit of a conundrum at times. Currently Gold demand is 85% investment and jewelry (which is mostly Asian and Indian = investment) and 15% commodity. Silver is more like 70% commodity / 30% investment (rough ballpark). Yet the current above ground warehousing of Gold far exceeds Silver. Only ~500 million ounces of Silver is being warehoused, which is roughly a year's worth of global mine production. The makes Silver *especially* susceptible to demand drive spikes (more on that in a minute).

Let's discuss the chart and asset class correlation:

Remember, the GSR is a ratio. From 1980-1991 an increasing GSR signified Silver falling faster than Gold. This was actually very bullish for the market. As the spike in Silver from the Hunt brothers fiasco led to a very manic Silver Run up in the 1980s and it corrected very hard down to its lows in the early 1990s. Money moved out of safe haven investments and into stocks. So in this case, a rising GSR in a falling gold/silver environment is bullish for stocks. And stocks did indeed make a spectacular bull run during this time.

Compare this to the recent past. A rising GSR in a rising Gold and Silver Environment means that that a premium is being placed on safety / risk aversion. A rising GSR in this scenario is *VERY BEARISH* for the equity markets. This was the case in 2000-2003 (Tech Bubble crash) and again in 2007-2009 (First Credit Bubble Crash / The Great Deleveraging Crisis of 2008) and what do we have right now?

That's right, the Gold / Silver Ratio is on the rise again.

What does this mean?

Silver, like the HUI, is a more speculative play that is tied to more positive economic correlation. That is, Silver is much more correlated to positive economic activity (where we have sustainable growth in commodities as fuel for productive economic endeavors). This optimism typically occurs during times of leverage and liquidity.

Gold is much more of the stalwart safe haven precious metal. It's moves are a lot less spiky than Silver's.

The GSR currently has room to run up. Assuming that we have another credit and/or confidence crisis, Gold will be the true safe haven move. During the next leg of the crisis Gold will vastly outperform Silver (IMO). I think the GSR could challenge the triple-digit level again.

**BUT** if it does that (and gold will probably be putting on its biggest move of the bull market at that time) expect a feeding frenzy in Silver (as demand for monetary metal heightens, expect Silver to behave like money and not at all like a commodity). And due to scant warehouse supply of Silver, also expect demand to skyrocket. At this point Silver will vastly outperform gold, and expect the GSR to plummet to 30 or less.

Here is my takeaway

I am bullish on both Gold and Silver and I think shorting it, for any length of time with any large portion of your portfolio, is a very bad call. I think demand for both will increase dramatically in the coming years.

I think Gold will lead the next phase of the crisis and outperform Silver.

But at some point the Gold / Silver Ratio becomes "stretched" so far, and demand for all Precious Metals becomes great, especially undervalued Silver, that Silver will skyrocket and outperform Gold.

So, Gold outperforms for the near term, Silver outperforms about halfway through the crisis. If you go by all my logic / observations above.

Here is some further required reading on Silver:

-- Jesse: Is the Price of World Silver the Result of Legitimate Market Discovery? - http://caps.fool.com/Blogs/ViewPost.aspx?bpid=312290
-- Golden Sextant Commentary - http://www.goldensextant.com/commentary35.html

Wrap-Up

The point of this post, just like the point of any of my posts, is *not* to try to convince you of anything. I am an analyst who is sharing observations. That's all. It is immaterial to me whether you agree or disagree with my observations or conclusions. But I do hope that my observations are useful in helping you to formulate your own opinion, even if your conclusion is completely opposite of mine.

22 Comments – Post Your Own

#1) On January 12, 2010 at 7:14 PM, kdakota630 (29.46) wrote:

Excellent.

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#2) On January 12, 2010 at 7:31 PM, Tastylunch (29.20) wrote:

So more or less exactly what Sinchi said in your last blog.

Power move in Gold, followed by a mother of  all mean corrective  manias in Silver 

Actually Binve this makes Silver seem like the better play in some ways...

funny I wonder what was special about 1991-1992 I remember it being  a down period but I did not remember it being an intense one.

One wonders if our real estate bubble might have never gotten so large if REITS weren't created/popularized around 1994...

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#3) On January 12, 2010 at 8:07 PM, workfor (< 20) wrote:

Excellent post binve. Makes perfect sense!

I'm curious about your view of possible large naked short positions  in gold and silver (especially silver) by institutions which may be artifically depressing G&S prices, and also affecting the G&S raio. To what extent do you believe this occuring?

 

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#4) On January 12, 2010 at 8:12 PM, workfor (< 20) wrote:

Sorry about comment #3 binve. I posted it before I read your link.

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#5) On January 12, 2010 at 8:17 PM, AvianFlu (37.42) wrote:

 I concur.

+1 rec

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#6) On January 12, 2010 at 8:54 PM, binve (< 20) wrote:

kdakota630, Thanks man!

Tastylunch, Hey man!

So more or less exactly what Sinchi said in your last blog. Power move in Gold, followed by a mother of  all mean corrective  manias in Silver 

Exactly. I very much agree with that assessment.

Actually Binve this makes Silver seem like the better play in some ways...

I am not sure I agree with that statement. I think there are compelling pros and cons to both metals. I am long both Gold and Silver in a big way. So I buy the bullish picture for both. But Gold is the real wealth protect. Silver is a lot more speculative. I mean, if we get a huge speculative spike in Silver, how many of us will be able to correctly time it? If you don't have the stomach, this metal will scare the sh** out of investors. This is the reason why I don't necessarily agree that Silver is the better play.

Both gold and Silver are long term investments for me, and I have cost averages well below current prices. But since I am betting on both the more stable rise in gold (which will still be *very* volatile) and the manic buying of Silver, I am more comfortable with my position than going all-in on one or the other. BTW, this is what make CEF an ideal investment in an lot of ways.

Sorry, that was a bit of a ramble, but I think you know where I am coming from :)

One wonders if our real estate bubble might have never gotten so large if REITS weren't created/popularized around 1994...

I think you are right about that. Thanks man!!

workfor, Thanks! I appreciate that! And LOL! no worries :)

AvianFlu, Thanks!..

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#7) On January 12, 2010 at 8:57 PM, XMFSinchiruna (27.35) wrote:

I expect the GSR to continue trending down over the long haul, and don't expect spikes to the upside of anywhere near the proportions that binve's chart suggests. Maximum I could see GSR hitting 75 or 80 during an anamalous event, but given the different supply/demand dynamics in silver I consider it more likely that GSR will continue to trend down from here ... and silver will outperform gold both in the near-term and the longer-term.

I was reducing exposure to gold in favor of silver when the ratio was recently above 65, and I won't be switching that allocation back to gold before the GSR approaches 50:1 (where it stood before the March 2008 correction).

binve ... these last few days are weird for me ... I'm not used to disagreeing with you. :)

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#8) On January 12, 2010 at 9:09 PM, binve (< 20) wrote:

TMFSinchiruna,

binve ... these last few days are weird for me ... I'm not used to disagreeing with you. :)

LOL! No worries man. If we all saw everything in exactly the same way then there wouldn't be a market for anything :)

And to be sure, with this analysis, just like with any of my analysis, it should be understood that it is one possible projection. Nothing more or less. It could play out like I suggest. Or it could play out like you suggest. Honestly, I bet it is somewhere in the middle.

I definitely agree with you that the GSR is much too high from the historical perspective and over the very long term (next couple of decades) Silver will outperform. This is definitely based on our rarity ratio discussions. Which means that the long term GSR should trend to 16-20. But before we get to that point, I think the world will experience another finanical crisis which will highlights both gold and Silver's usefulness as a monetary asset (too many people still consider Silver, and gold for that matter, a commodity).

This is where my spike sceanrio comes in. I think the world is still too complacent with finanical assets and Silver's role as a commodity. Something has to shake that up.

Also you can see the 20 year down channel for the GSR, and how the last crisis has changed the trend back to up. This is why I think the GSR is forecast some major volatility still.

Just my $0.02. And as always, thank you for your input, comment, clarifications (and when needed, especially with me) corrections :)  I still think we see the big picture (next several years out) for gold and silver exactly the same, which is why I am hugely bullish (and own a lot of) both gold and silver. Thank you my friend!..

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#9) On January 12, 2010 at 10:30 PM, Sozurmama (22.29) wrote:

Now you may be a gold bear, and think it is a useless shiny piece of ... metal. But the odds of someone of that mindset actually making it far down this post is probably unlikely.

O ye of little faith

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#10) On January 13, 2010 at 10:15 AM, XMFSinchiruna (27.35) wrote:

Sozurmama

kudos :) That's the kind of open-minded investigation that leads to tremendous success in investing.

binve

My primary piece of evidence supporting expectations for silver's outperformance over gold in the near-term is the fact that silver has still not broken out technically from the March 2008 correction. When gold retakes the last high and begins its trek towards $1,650 (which might come faster than many anticipate), silver is bound for a monstrous upward surge to break out of its corrective phase and approach 50:1 in short order.

In other words, I expect $25 silver by about the time gold hits $1,350 to $1,400.  By $1,650 gold, I believe silver will trade firmly above $30.

Then again, I hope you're right about the GSR hitting 100 ... as that would bring about the mother of all arbitrage situations, and I would move just about every gold-related equity I own into silver. I just don't see it happening.

However it plays out, I look forward to playing arbitrage between the two metals by shifting some allocation back and forth strategically throughout the remainder of the bull market. At $1,200+ gold I sold 10% of my equity holdings in gold. When the GSR moved above 65:1 during the recent sell-off, I put most of that allocation back into silver equities. This is my version of a FOREX trading account. :P

Fool on!

 

 

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#11) On January 13, 2010 at 10:35 AM, binve (< 20) wrote:

TMFSinchiruna,

Thanks as always for the comment and discussion. This is very good, because we are able to show and offer two differnent interpreation of the near term behavior of gold and silver, but yet both of our analysis 100% agrees for the long term - Silver is an absolutely massive winner.

My primary piece of evidence supporting expectations for silver's outperformance over gold in the near-term is the fact that silver has still not broken out technically from the March 2008 correction. When gold retakes the last high and begins its trek towards $1,650 (which might come faster than many anticipate), silver is bound for a monstrous upward surge to break out of its corrective phase and approach 50:1 in short order.

Absolutely. I agree that is a very viable interpretation. But let me offer a counterpoint to this argument.

Gold broke out to new highs in the midst of an equity rally yet silver did not. These tells me that there are skeptics on the rally and there is still a lot of demand for safe money. But not enough demand yet to give undervalued Silver its big boost yet. There are still too many people that consider it a commidity. Hence new high for gold, and not a new high (yet) for Silver.

And I think we are going to get another severe correction/crash in the stock market (and several asset classes this year). And I think gold is going to do exceptionally well. Because the next crisis will be a confidence crisis. It will be a no-vote against fincials bailout / shennanigans / monetary policy, etc. And gold will shine like a safe haven investment.

And yet until gold *clearly* outperforms during the next leg of the crisis, most people will not consider Silver as a sound money alternative. But when gold starts hitting close to $2000/oz and Silver is still waiting to break out around $20/oz and Stocks are beginning to accelarate downward, then I think Silver makes it **huge** bold jump.

That is the sceanario this post paints.

And like I said, it is just one of many possible sceanarios. But when I look at the GSR trends, the HUI/Gold Trends, and the Wave counts for the broad equity markets, I think this is a very viable scenario.

Then again, I hope you're right about the GSR hitting 100 ... as that would bring about the mother of all arbitrage situations, and I would move just about every gold-related equity I own into silver

Exactly :) I think this would be a gift. Whether it comes to pass? I don't know. But it is possible.

This is why I own both gold and silver right now. I think both will outperform the equity markets, and there will be some period of time (in my mind) where gold will probably outperform silver and then a period of time where silver will probably outperfrom gold.

And since it is no slam dunk on when this outpeformance will occur between the two, I own both :) Long live CEF!  :)

Thanks again for a fantastic discussion!!!..

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#12) On January 13, 2010 at 10:36 AM, binve (< 20) wrote:

Sozurmama, LOL! gotcha :)..

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#13) On January 13, 2010 at 11:37 AM, XMFSinchiruna (27.35) wrote:

binve

Indeed, thanks for a very thought-provoking discussion. I will take some time when I get a breather to reflect on the topic.

That said, I could reflect for months like a monk on a clifftop, and still never envision a scenario in which silver could remain under $20 as gold approaches $2,000. :) $2,000 gold, in my opinion, will find silver closer to $50.

Here's a really nice set of charts on the GSR that I'd like your reaction to.

http://www.gold-eagle.com/charts/gegsr.html

I think you'll appreciate how the first two sets of charts show that it is price moves in silver that dictate its ratio relationship with gold, and not price movements in gold. I found that a fascinating point to ponder. 

Thanks for getting the gears turning on one of the most important topics for precious metal investors to understand.

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#14) On January 13, 2010 at 11:41 AM, outoffocus (22.75) wrote:

I'm with Tasty.  Reading this blog actually makes me want to lean more toward silver.  Yea silver may seem more speculative, but silver is currently very fairly priced while gold is outrageously expensive price wise. Even if you silver scenario plays out, the downside potential is minimal.  Think about it. One ounce of gold cost more than one months rent for me while one ounce of silver costs less than a bag of groceries from Walmart. If the economic scenario you predict plays out and gold speculation increases due to safe-haven investing, I think the law of substitutes will start to come into to play and smaller time investors will look to silver as a cheaper alternative to gold.

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#15) On January 13, 2010 at 12:15 PM, AvianFlu (37.42) wrote:

Consider this:

Debasing of the currency has been massive and unrelenting. Regardless of the tough talk the Fed will not be able to prevent inflation. Any significant uptick in inflation will cause a massive rush towards the perceived safety of gold and silver, as even metal skeptics such as myself attempt to preserve capital.

In this scenario silver wins because of the smaller denominations more suitable to barter.

In this scenario silver wins because it is less subject to federal confiscation a la 1934 gold due to it's many industrial uses. Banning ownership would not be practical.

In this scenario silver wins because of the historically out of whack gold/silver ratio. The ratio could also be corrected by gold dropping in price. I don't see that happening in view of the rush to gold by central banks and big players.

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#16) On January 13, 2010 at 12:33 PM, XMFSinchiruna (27.35) wrote:

 outoffocus

"silver is currently very fairly priced while gold is outrageously expensive price wise"

I respectfully submit that this is an incorrect interpretation. Both are severely undervalued relative to the fundamental landscape because both are blatantly manipulated markets in which the bullion banks have had their way with containing price advances and triggering corrections throughout this bull market using the leveraged paper markets of the futures exchanges, yet they are not equally undervalued.

AvianFlu

Correct, silver wins in all scenarios that have passed before my mind. :) But that doesn't stop me from keeping about 1/3 of my precious metals allocation in gold.

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#17) On January 13, 2010 at 12:58 PM, outoffocus (22.75) wrote:

TMFSinchiruna

Maybe I didnt make myself clear.  I didnt say gold was expensive fundamentally.  I say gold was expensive "pricewise".  I tried to explain that by saying:

One ounce of gold cost more than one months rent for me while one ounce of silver costs less than a bag of groceries from Walmart.

In other words, not everyone who will seeking to preserve wealth has 100k to drop on gold bullion at $2000 an ounce.  Therefore they will be seeking a cheaper alternative.  Here comes silver at less than $100 per ounce.  Say you have $25000 you want to protect from inflation.  Which seems like a better deal? (assuming $2000 gold and $20 silver) 12.5 ounces of gold or 1250 ounces of silver?

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#18) On January 13, 2010 at 2:25 PM, binve (< 20) wrote:

TMFSinchiruna,

Aboslutely man!

That said, I could reflect for months like a monk on a clifftop, and still never envision a scenario in which silver could remain under $20 as gold approaches $2,000. :) $2,000 gold, in my opinion, will find silver closer to $50.

LOL! Fair enough :)

Those are some great charts! Here is my interpretation on the GSR long term one:

ENLARGE

I think you'll appreciate how the first two sets of charts show that it is price moves in silver that dictate its ratio relationship with gold, and not price movements in gold. I found that a fascinating point to ponder. 

That is indeed very intresesting!.

Thanks for getting the gears turning on one of the most important topics for precious metal investors to understand.

Absolutely!! I think it is important to showcase a few different interpretations. And I think the true key takeaway here is that a rising GSR isn't necessarily bearish for Silver. It might be it holds back in the short term, but will explode more forcefully in the long term. Which is what I was trying to show. In either case, I remain very bullish on Silver :) Thanks man!

AvianFlu, Yep, I agree :) Thanks!

outoffocus, yep, I definitely see your logic:

In other words, not everyone who will seeking to preserve wealth has 100k to drop on gold bullion at $2000 an ounce.  Therefore they will be seeking a cheaper alternative.  Here comes silver at less than $100 per ounce.  Say you have $25000 you want to protect from inflation.  Which seems like a better deal? (assuming $2000 gold and $20 silver) 12.5 ounces of gold or 1250 ounces of silver?

Yeah, someone might want to buy physical in $100 installments. You could be 1/10 oz gold piece (which has *HUGE* premiums) or 5 oz of Silver.

I think PMs will really take off once the mass public begins to consider it for saving (just like the Chinese and Indian public is doing). Silver is very attractive from this standpoint.

Thanks!..

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#19) On January 13, 2010 at 5:26 PM, Tastylunch (29.20) wrote:

yeah that's the problem with Gold discussions. Even when people agree they often use the phrase "gold" to mean many different things. Physical, miner, Etf, futures  people call all these things "Gold" and one might be a good buy while the rest aren't...

I guess what I was saying Binve, is assuming the downside risk on Gold and Silver is roughly the same and even if Gold outperforms in the short term, the potential reward for silver seems greater therefore. The R/R might favor silver

but that's assuming the downsid risk is equivalent (which it likely isn't)

But it's like  debating over an A- vs an A.  Assuming the overall thesis is correct you will be fine either way.

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#20) On January 13, 2010 at 5:31 PM, binve (< 20) wrote:

Tastylunch,

Gotcha man. In that case, I completely agree with you :)

But it's like  debating over an A- vs an A.  Assuming the overall thesis is correct you will be fine either way.

LOL! Amen to that :)

"Better is the enemy of good enough"

It is true in engineering design and it is true for an investing thesis. Maybe gold outperforms, maybe silver outperforms, and maybe they switch places a few times. Just buy both and don't worry about it :) . Thanks man!!..

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#21) On January 13, 2010 at 7:04 PM, NOTvuffett (< 20) wrote:

I agree that silver is seen more as a commodity, the gold bugs always scared me.

Yesterday the Alcoa earnings miss and the news that China is doing things to rein in their growth rate dragged down the market, especially materials.  I used this weakness to add to a small position in a silver miner I started right before Christmas, and I got a 3+% boost today.

If anybody is betting heavily on silver, I guess they prey for the reincarnation of the Hunt brothers that tried to corner the silver market, lol.

binve, your mention of engineering reminds me of a story I read 30 yrs ago (maybe it was written by Kipling).  It was about an engineer that designed a carriage with parts so precisely engineered that the whole thing fell apart at once, lol.

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#22) On January 14, 2010 at 9:13 AM, binve (< 20) wrote:

NOTvuffett,

If anybody is betting heavily on silver, I guess they prey for the reincarnation of the Hunt brothers that tried to corner the silver market, lol.

Not necessarily. I am not, and I am betting heavily on Silver. The Hunt brothers fiasco was due to a very small group cornering the market. Demand was artifical due to extreme manipulation.

The situation I am proposing is that I believe Gold will be the premier safe haven asset during the next financial crisis (which is a debateable point, actually two, that gold will be or that we will even have another financial crisis). When gold really starts to take off because there is an increased demad for safe haven assets, Silver will be looked at as an undervalued brother of Gold. It has been money historically, but the last 50 years has seen it transition to be viewed more as a commodity. I think it will resume its role as a monetary asset during the next major crisis.

My point is, even if just a fraction of the gold investors start turning to Silver as well, a demand crisis is already built in. Because the warehousing ratio of Silver to Gold is tiny. Most people do not realize the extreme imblance. Silver is 16x more abundant than gold, but the warehousing ratio is almost flipped. So I don't think a Hunt bros manipulation scenario is required to drive a feeding frenzy in Silver, just slightly increased legitimate demand from investors will do the trick (IMO).

binve, your mention of engineering reminds me of a story I read 30 yrs ago (maybe it was written by Kipling).  It was about an engineer that designed a carriage with parts so precisely engineered that the whole thing fell apart at once, lol.

LOL! Nice :)..

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