A Crash Wave in Gold

On Monday, futures traders holding long positions in COMEX gold futures woke up to an additional $8,000 loss per contract when the COMEX opened for trading. Not surprisingly, a panicked liquidation ensued and a new record high in trading volume was set – handily exceeding the total open interest in the June contract. In a way this was reminiscent of the 1987 crash in the stock market, as the market at the time also opened with a huge gap down after breaking through a major support level on the preceding Friday. It then proceeded with liquidation selling on extremely high volume that would last throughout the day, with the market finally closing right at its lows. The daily chart of the June gold futures contract indeed looks like a fairly typical crash chart (and so does the weekly continuation chart, see further below).



Gold, June contract

Gold, the most active June 2013 contract. The crash wave has produced record trading volume. A small bounce has begun today, as shorts are taking profits – click on chart for better resolution.



On a daily continuation chart that collates the trading volume of all futures contracts combined, we can see that trading volume reached an all time high of nearly 657,000 contracts, also exceeding open interest by nearly 50%. The next CoT report to be published this Friday is going to be interesting, to say the least.




Gold front month, daily continuation – in all futures combined, trading volume hit nearly 657,000 contracts – click on chart for better resolution.



When we wrote yesterday's update over the weekend we were of course unaware that this was going to happen, but we did mention the following: “A word of caution: if a severely oversold market just keeps falling, then there is sometimes a lot more short term downside in store.”

Obviously, a 'lot more short term downside' was indeed in store. It is of course impossible to tell at the moment how much lower gold might go before it finds a durable low, but there are a few target areas one can consider at this point. For instance, the $1,300 level roughly coincides with the 50% retracement of the 2008-2011 rally, as well as the 38% retracement of the entire bull market from 2000-2011. So this is an area that could provide support.

A more painful possibility is of course that gold could replicate its 1975-1976 mid cycle correction, in which case the lateral support at $1,040 might come into play at some point down the road. We simply don't know at this point, we only mention these levels as something one needs to keep in mind.

Also worth noting is the fact that reportedly, physical demand in Asia has spiked higher as a result of this rout (those inscrutable Asians apparently like to buy low), which is evidenced by premiums on various gold bars and coins that are popular in places like China and India soaring in recent days. According to press reports, there is not enough scrap available to quickly produce gold in the forms and sizes that are seeing the greatest demand, a situation that reminds us of what happened at the depths of the 2008 correction.  In the meantime, we have given some thought as to what it actually may be that is bothering the gold market so much.


What is Really the Problem?

In recent days a number of reasons have been forwarded as to what triggered the rout in gold, some of which sound quite reasonable, while others are just obviously hokum. We are referring to fundamentals here, not technical conditions – obviously, breaking important support levels always triggers technical selling, as stops are taken out. Recall that over the past two years many analysts have made a big deal about central bank buying of gold. This never made any sense to us. How can 400 or 500 tons of net central bank buying in a whole year have any appreciable influence on a market the total supply of which is approximately 170,000 to 175,000 tons and that trades between 2,000 and 3,000 tons every day worldwide?

All one can really say about central bank buying is that it is very likely a contrary indicator, as central bankers as a rule are the worst traders in the world. After all, they were all selling hand over fist while gold declined from $400 to its low at $250 in the late 1990s and then kept selling hand over fist while it rallied from $250 to $1,000. Their decision to start buying at prices ranging from $1,500 and higher must therefore be regarded as suspicious and QED, it certainly wasn't a bullish omen at all.

However, considering the timing of the recent crash and the news backdrop surrounding it, it seems actually quite likely that concerns about central bank holdings were what provided the psychological trigger for the sell-off. As a number of observers have argued, the news that Cyprus will probably have to sell its measly 10 tons of gold reserves sparked visions of Italy, Portugal or Spain having to do the same eventually. Not that it makes a lot of sense worrying about that either: in reality, the gold would likely be used as collateral for loans, or be transferred to other official holders (probably Asian ones) without ever hitting the market as such.

Moreover, try to imagine a situation where e.g. Italy's economic situation becomes so dire that is is forced to think about selling its gold. We believe that if it were to come to that point, the euro project would finally be rendered asunder. European nation states would then return to issuing their own fiat currencies again and would likely begin to inflate all out in the misguided belief that this flight forward might actually help them. It is either that, or the ECB will give up all pretense of being responsible and begin to inflate all out rather than risk the euro project's doom. However, all of this is probably in a still fairly distant future anyway, so it cannot really be the main reason behind the rout in gold – the Cyprus story and the deliberations flowing from it merely provided a trigger.

Also, as far-out as that may sound, Jim Rogers may actually have a point when he says that the crash in Bitcoins could have had a psychological effect on the gold market as well. After all, if one state-less alternative currency is crashing, then it seems only logical that the other state-less alternative currency should do the same. And Bitcoin has certainly crashed, although we would regard that simply as part of its growing pains. Unless government manage to crack down on it somehow, Bitcoin isn't going to go away and its finite supply almost guarantees that it will continue to gain in value over the long term. Let us not forget, Bitcoin already crashed once in 2011, falling from more than $47 to slightly above $2. Its imminent demise was darkly prophesied at the time by the same people who are at it again today – all or most of whom are committed statists, we might add,  this is to say, the usual suspects. They moaned and griped when it went up, alleging that its apparent soundness made it a 'bad currency' and now they moan and gripe even more loudly as it is going down. However, it isn't going to go away and we are willing to bet that in ten years time, its exchange value will be far higher than today's. We will explain this stance in some more detail in an upcoming post.



Bitcoin crashes as well – click on chart for better resolution.



So what is actually the problem, what important fundamental development may have upset the gold market?

We believe it actually does have to do with Cyprus, in an indirect way. When analyzing gold, one must never lose sight of the fact that it is a monetary metal, and investment demand for it can therefore be described as monetary demand. A such it competes with other currencies, most of which can be created in unlimited quantities by central banks with the push of a button.

However, what happened in Cyprus was a timely reminder that the fiduciary media created by fractionally reserved banks are ephemeral indeed and can  be sent to money heaven at any time if the authorities so decide. Readers may recall that we have amply documented here that the Cyprus 'non-template' is now actually considered the template for dealing with insolvent banks – and not only in the euro area, but worldwide

At the same time, it has come to our attention that bank credit expansion is slowing down lately, respectively even going into reverse in many regions of the world, in spite of heavy monetary pumping by various central banks.

In short, what the gold market may really be worried about is the deflationary potential of all these events. It is quite conceivable to us that another major deflation scare is just around the corner; after all, Europe's wobbly banks haven't magically become solvent overnight – they are merely temporarily reliquefied by the ECB's LTROs. Consider for instance the weakest of Germany's big banks, Commerzbank. Its CEO Martin Blessing is quite adamant that dispensing haircuts to depositors is the way forward. He is also, as Der Spiegel points out, an incorrigible optimist and bad market timer:


SPIEGEL: Mr. Blessing, you have recently again used a good portion of your annual salary to purchase Commerzbank shares. What are you — a gambler or an incorrigible optimist?

Blessing: Neither. I'm a long-term investor and a staunch supporter of Commerzbank. In this combination, I feel very good about my investment.

SPIEGEL: Despite the fact that you once purchased shares at a price of €30 ($39) and the shares are now worth €1.17 ($1.53)?

Blessing: I have purchased Commerzbank shares on a regular basis and have never sold any — and I won't do so, either, as long as I'm active. Of course Commerzbank shares have been hit hard by the financial and sovereign debt crisis over the last few years. But that is true of all shares, particularly shares in banks.

SPIEGEL: Not many have fallen from 30 to just one euro in value. How far would the price have to rise for you to recoup your losses?

Blessing: The current price would have to roughly triple.

SPIEGEL: Taxpayers — who will still have nearly a 20 percent stake in the Commerzbank even after the planned capital increase — aren't doing any better. How do you intend to triple the price?”


“Blessing: In late 2012, these business activities — public-sector financing, shipping financing and commercial real estate financing — still made up €151 billion. By 2016, we intend to reduce this to slightly more than €90 billion. Currently, these reductions are going faster than planned.”


(emphasis added)

The important point is of course the last sentence – where Blessing explains how he plans to triple the share price to recoup his losses. Namely, by shrinking the bank's credit exposure.




Commerzbank share price with time line, via Der Spiegel – click on chart for better resolution.



Commerzbank may be an extreme case, but roughly similar deliberations are informing the banking business across Europe – definitely no-one is seriously considering growing their loan book. Besides, there is very little credit demand anyway. This is inherently deflationary. However, letting the deposits of depositors in insolvent banks go up in smoke is even more so, even if it is the right thing to do (it is definitely more just than simply stealing money from tax payers to prop these failed banks up). As an aside, a budding plan to simply cancel all € 500 banknotes under the pretext of 'hitting organized crime' may produce a big profit for the ECB, but it would be intensely deflationary as well.

Naturally, there is every reason to doubt that the authorities will allow a system-wide deflation to happen if push really came to shove and the entire € 3.5 trillion in fiduciary media issued by commercial banks in the euro area were in serious danger of evaporating. This is even more true in the case of the US banking system and the roughly $7.8 trillion in fiduciary media outstanding there. However, we do think that a deflation scare has a high probability of occurring within the next year or two and that the decision to allow depositor haircuts to happen is imparting a certain impetus to this.

In short, gold's recent crash is probably an expression of growing market fears that a hitherto unexpected deflation scare may be on its way as a result of the decisions that have been taken regarding the status of big depositors following the Cyprus 'rescue'.


Addendum: Technical Conditions

As an addendum to yesterday's update, we want to show the weekly and daily charts of the HUI – the weekly RSI has now declined to an improbable new all time low of just 17.38, and it seems quite possible that the recent gaps in the chart represent so-called 'exhaustion gaps'.




The HUI, weekly – the gap at the end of the decline may be an exhaustion gap, especially as it coincides with an RSI of just 17.38. Hopefully it isn't a 'measuring gap', see the next chart as to why- click on chart for better resolution.




On the daily chart of the HUI we can see both potential 'measuring gaps' as well as the two potential exhaustion gaps in the latter stage of the decline. Note that an RSI-price divergence has formed as well on the daily chart (though not on the weekly chart – there is a remote possibility that the gap on the weekly chart is actually of the 'measuring' variety) – click on chart for better resolution.



Meanwhile, the 'Gold VIX' GVZ has of course continued to soar in Monday's session and looks slightly 'overbought' now:




GVZ goes ballistic as the implied volatility of GLD options soars – click on chart for better resolution.



Not surprisingly, the XAU-gold ratio has hit a new all time low as well (the BGMI-gold ratio, which has a longer history, remains at its lowest level since the Pearl Harbor market crash of 1941-1942).



XAU-gold hits a new all time low – click on chart for better resolution.



Finally, a weekly chart of gold brings home how eerily similar the crash thus far looks to other historical financial market crashes:




A classical crash chart – note that gold's weekly RSI landed at a mere 18.73. – click on chart for better resolution.




It is not possible to tell where the ultimate low of this move will be. What we know for certain is where various areas of support and resistance are (note in this context that the $1,525-$1,540 area will henceforth be stiff resistance, as it has held almost two years as a support line) and that gold sentiment has morphed from 'intensely bearish' to 'outright panic'.

Above we have speculated as to what the decline in gold may be telegraphing and what the worries underlying its decline may really consist of. Naturally, should authorities allow many more banks to go under and take their deposits with them into oblivion, then the supply of the underlying currencies will begin to shrink. This would be genuine deflation and it would be normal for these currencies to gain in value against gold (deflation is not possible in gold). However, we also believe that these and other worries in the context of potential central bank gold sales in the euro area are quite overblown. It should be clear that not a single central bank in the Western world will in the last resort allow deflation to truly take hold. They would probably rather 'go Weimar' on us than allowing that to happen. In fact, a budding deflation scare all but ensures that even more money printing will eventually ensue. Note in this context that ECB governor Benoit Coeure recently already remarked that there is allegedly 'not enough inflation' in the euro area:


“The European Central Bank will monitor euro zone inflation carefully over the next 18 months as it threatens to sink further below the ECB's 2 percent target, Executive Board member Benoit Coeure said on Friday.

Euro zone inflation slipped in March for a third straight month to an annual rate of 1.7 percent, compared to the ECB's goal of close to, but not above, 2 percent.

"We have a rate of inflation which looks set to move away from the ECB's 2 percent target over the next 18 months," Coeure told reporters at a breakfast event, adding that a drop in inflation was as worrying as a rise. "It is still fairly close to the 2 percent target but it is moving below that goal and this is something the board of governors is clearly following as we have a goal of 2 percent," Coeure said.”


(emphasis added)

There you have it. Not even a mild decline in the CPI inflation rate below the 2% 'target' can occur without triggering the urge to increase the pace of monetary pumping. It seems abundantly clear to us that no genuine deflation will ever be allowed to happen – therefore the market's fears over this possibility seem quite misplaced.



Charts by: Bloomberg, StockCharts, BarCharts, Der Spiegel, Bitcoincharts



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22 Responses to “Gold’s 1987 – What is Really Bothering the Gold Market?”

  • Monty Capuletti:

    Jason Emery,

    I don’t measure CPI using “the way it was measured in the ’70’s”, and nor should anyone who is expecting to make any money in the market, gold or anything else.

    I measure REAL interest rates using both ( 10 Yr nominal yield less Y/Y Change of CPI (Non-Seasonally adj) ) and I do the same for 2 Yr vs CPI…Standard, simple difference between the 2 variables. And no, I am not mistaken. Both those #’s troughed in 3Q’11, in concert with gold’s peak, and real rates have been trending slowly higher ever since.

    You can use any measure you want, but perhaps you should consider how most market participants will consider this metric, rather than substituting an un-used (except by a hyper-inflationary coot like John Williams- Was it 2010 when we were going to see a hyper-inflation? Or 2011? Or Definitely 2012 right? Or 2013? PLEASE) metric that will never make you any money…This is exactly the kind of crap that so irritates me about the unabashed bugs who have now had their as@# handed to them, all the while proclaiming that everyone else doesn’t get it. Good luck with that.

  • No6:

    Cyprus yes, I agree
    But if Gold were sniffing a deflation in Europe how come the other markets haven’t got the news yet?

    You say “It should be clear that not a single central bank in the Western world will in the last resort allow deflation to truly take hold.” Agree. But Cyprus ushered in something central banks will allow and is very bad for Gold. Capital Controls.

    Gold didn’t just fall in price. This was a colossal crash based on panic. Money is on the move in Southern Europe and Gold fails the safe mobility test as witnessed on the Swiss boarder 2 weeks ago. This is possibly why Bitcoin was bid up but it simply could not handle all the new attention.

    Add this to the predicted initial QE ‘high’ and ‘no hangover in sight’ mentality and Gold has no function, yet. Heck some optimists even believe that the US will enter a trade surplus by 2020 due to all this cheap energy they will be able to sell.

    But all of this only explains a fall in Gold, not a crash. I think Gold would have easily held its strong support, it was already very over sold. What caused the crash was a two pronged concentrated 400 ton of Gold dumped on NY like King Kong, which is crazy trading unless some entity wanted to trigger stops. Shock and Awe style.

    Panic undoubted, but who or what was panicking? and why?

  • Monty Capuletti:


    If we use your assertion that Cyprus is now the “non-template” template for bank resolution, isn’t that effectively a return to “sound money” and exactly the prescription one would follow in a “hard-money” system where fiat currency creation isn’t used to cover the non-economic decisions of rational actors? Forcing losses on bad decisions seems exactly what a sound banking system should aspire to, and while leaving jr bond-holders untouched violates a host of other norms (& laws), NOT merely papering over another banking problem (the German way), the Cyprus template seems a Euro positive, hard money +, and a profoundly gold negative solution, as markets interpret these actions as the new course for Europe, and with US central bank jawboning about the end of QE and global growth expectations moving downwards (ck out 5 & 10 yr B/E’s) it is a profound negative for gold.

    As I wrote last week, real interest rates troughed in 3Q’11, just as gold hit it’s peak, making the “gold as inflation hedge” less and less credible as we see developed world CPI’s and BE’s continue to drop.

    It’s just one reader’s opinion, but I applaud your effort in at least seeking to understand the root causes of what’s just transpired, as opposed to most other blogs that simply cry conspiracy and limp off with (to my eye) their credibility shattered and their investment records neatly destroyed.

    • JasonEmery:

      Monty said, “..real interest rates troughed in 3Q’11”

      You are mistaken. 10-yr treasury yields in 3Q 2011 were about the same as where they are now, a bit below 2%. And consumer price inflation, as it was measured in the 1970’s, was about 8%, and is now currently between 8% and 9%. So real rates are unchanged since then.

  • jimmyjames:

    There is a lot of talk about this crash mirroring the 1975-76 correction. But, isn’t it just as possible that this is something like 1980 instead?


    It really doesn’t look much like 1975-76 and especially not like 1980 to me-


    • bart:

      Using a YoY change metric suppresses the size of the 70s move since it lasted well over a year.

      12/74 – ~$195
      8/76 – ~$104

      And it’s only your assumption that gold will not go through a similar or rhyming ~50% correction now, and then bounce back up to $5,000 or whatever peak.
      Or just have the 70s rhyme get cut short at the current ~32% correction – history isn’t known for perfect repeats/

      • jimmyjames:

        And it’s only your assumption that gold will not go through a similar or rhyming ~50% correction now, and then bounce back up to $5,000 or whatever peak.


        I guess you will have to point out to me where you believe i have made any assumptions about forward projections-
        The chart only shows the past to this date and that was all i was pointing out- so where do you see any similarities in yoy % swings from those time periods that reflect anything that’s taken place in this ongoing 12 year market to date?

  • shortwave:

    There is a lot of talk about this crash mirroring the 1975-76 correction. But, isn’t it just as possible that this is something like 1980 instead?

  • JasonEmery:

    First of all, we’re in a very ‘negative real rates’ environment. Consumer price inflation, as it was measured in the 1970’s, is running about 9%. With 10-yr treasury bonds yielding less than 2%, real rates are about as negative as they have ever been on a sustained basis.

    Secondly, oil now costs about $75 to find, drill, produce, refine, transport and sell, so it will not fall much further for a sustained period of time, unless world consumption were to drop by 75% and only a few low cost super giant fields could supply the planet.

    The most important fact one must know is that on a GAAP basis, the US fiscal deficit for 2012 was $6.9 trillion. Obviously, a country the size of the USA cannot run fiscal deficits of 40% of GDP for very long. For one thing, we have already borrowed (along with the EU zone) most of the world’s savings, so further borrowings must perforce, be of the QE (out of thin air variety).

    Therefore, this system is going to break down shortly. There are many logical explanations as to what might follow in the near future. One is that they are driving down gold to to do a confiscation on the cheap. Another is that they are liquidating paper longs to get long themselves. Perhaps they are trying to b.k. the miners in order to buy them up cheap. Lots of illegal things these masters might be up to.

    They are openly manipulating interest rates and the stock market, and now gold. So what else is new?

  • jimmyjames:

    The Gold bull since 2003 was a result of the Greenspan Fed turning interest rates negative after the tech bust.

    By 2008, the housing bubble had burst, turning interest rates positive.


    I think you have both those statements backwards and also–Greenspan found out that the Fed had very little influence over rates…


    In 2003 the FFR was pushed lower to flat and the long end was climbing- Greenspan started raising rates in 2004 and by 2006 the long end was falling-

    By 2006 Greenspan had raised the FFR to the point the FFR was higher than the 30 yr. and then the whole long end started inverting- “the great conundrum”
    Greenspan then “followed” the long end lower and i really wonder today- if the same thing might not happen if Bernanke halted QE and tried raising rates (not that he would) at least at this time- but anyway other than noise like 2008-gold powered up all the way through-
    imo–gold and the long bond have had a fairly tight inverse relationship since 2001-

    • SavvyGuy:

      Starting last Fall and up until last week, the Japanese yen was steadily falling, and was the only major currency in which gold was rising. Just my humble opinion, but as the JPY found a floor last week and started rising a little, the “short yen – long gold” trade needed to be unwound.

  • rahul:

    There is only one environment in which it makes sense for Gold to go up, and that is negative real interest rates. The Gold bull throughout 70’s was a result of interest rates lagging inflation. As soon as Volcker raised interest rates above inflation, Gold topped out. The Gold bull since 2003 was a result of the Greenspan Fed turning interest rates negative after the tech bust. By 2008, the housing bubble had burst, turning interest rates positive. The reason for the current Gold bull run is probably because of negative rates in China. The reason Gold prices have started coming down is because the china bubble has burst, turning interest rates positive. Since Gold pays no interest, there is no reason for Gold to appreciate in a positive rate environment.

  • georgew:

    Another excellent post Pater! Thanks!

  • zerobs:

    The central banks won’t allow overall deflation. So one can safely assume that investment accounts in bonds and equities will not be given haircuts except in a very small percentage of insolvent financial houses. But they are just fine in allowing deflation in commodities. A drop in commodities can be spun to sound like good news, deflation in stocks and bonds can’t be spun as anything other than a drop and a lack of confidence.

  • rahul:

    Most austrians are suffering from the delusion that Gold is coming back as currency that is why they somehow expect Gold to “appreciate” while everything else “depreciates”. As debt is paid off or defaulted upon, the currency it is denominated in must appreciate, in this case dollar has that role. If economic activity slows or people are forced into unemployment or retirement, they have to liquidate their savings to support consumption. If the savings are in the form of emply condos in India or China or other questionable investments such as ponzi wealth management products which are hard to liquidate, what gets sold is what is easy to liquidate such as gold. The 2008 selloff in Gold that preceeded the GFC should be a tipoff to Austrians about how Gold will behave in a crisis. Another thing to consider is that Gold price is intrincically linked to the price of oil because the biggest cost of extracting Gold from mother earth is the energy cost. So if oil price collapses due to an economic depression, Gold has to follow since the marginal cost of extracting Gold becomes cheaper and cheaper. If energy cost drops to $ 0, we could theoretically boil the oceans and extract as much Gold as we wanted and so the Gold price would also drop to $ 0. This is an extreme example but it shows you why Gold and Oil tend to go up or down together.

    • worldend666:

      I don’t follow your logic Rahul. Gold production is a tiny fraction of the supply. Most of the supply of course is already above ground.

      Even if the cost of extracting gold were to fall to 1/10 of the cost it is now there is a physical limit to what can be mined in a year. The real factors moving the gold price are perceptions of monetary conditions, not mine supply.

      • worldend666:

        I think you might also find a more likely reason gold tracks oil is that many oil producers, especially in the middle east recycle their petrodollars into gold. It certainly makes more sense than holding worthless US paper.

      • SavvyGuy:

        1) There is a certain logic to the argument that an ounce of gold is really so many barrels of oil condensed into a shiny coin in the palm of your hand (currently about 15.4 barrels per oz). A long-term chart of the Gold/Crude ratio (GC/CL) shows a well-defined channel. This is not a huge surprise, because gold miners would be eager to hedge their revenues against their input costs, thus defining the channel boundaries.

        2) All pricing of everything is set at the margin, and affects the main. Yes, annual gold production is a tiny fraction of the above-ground supply, in the same way as 2 houses for sale in my neighborhood are a tiny fraction of the number of houses in my neighborhood. But the sale price of those 2 houses will affect the price of all houses in my neighborhood!

        • worldend666:

          Hi Savvyguy

          >> 2 houses for sale in my neighborhood are a tiny fraction of the number of houses in my neighborhood.

          Yes, but the correct analogy would be to compare mine production to house production. Obviously house builders compete with the broader market when they set prices, and house builders make up only a small percentage of houses for sale. Even if houses become dirt cheap to build the demand will overwhelm supply of new houses by builders until such time as the builders are able to ramp up production, meaning prices would stay high for a considerable time after the building cost had fallen.

          • SavvyGuy:


            My point was that transactions at the margin set price discovery for the main. I agree with you that there is a time lag between price signals and increased production, which can lead to elevated prices in the interim.

    • I want some of what you are smoking Rahul. It would still take capital investment to get gold out of sea water and energy wouldn’t go to zero under any case. At some point, save for payment of debt, people with something of value to exchange aren’t going to want paper, as it is clearly being issued by a group of bankrupts with no mathematical solution to fix the insolvency. Despite the period of pain it would bring, any remaining individual freedom left in the world will depend on the system of world finance going broke and losing its influence. With these people, Necessity knows no law.

  • worldend666:

    There is only one flaw I can think of with your hypothesis and that is if the world is afraid of euro deflation why has the euro not risen proportionally against the dollar as it did against gold?

    The currencies are virtually unchanged whilst gold plummets. A currency like the the Singapore dollar is unlikely to see deflation as it has a sound banking system, yet it has not depreciated against the euro. Over the recent period of gold’s weakness the SGD has actually appreciated vs euro: http://sg.finance.yahoo.com/echarts?s=EURSGD%3DX#symbol=EURSGD=X;range=3m

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