The Great American Gun Bubble

Includes: AOBC, CAB, RGR
by: Larry Trefz

As it became clear that Barack Obama would win reelection, gun sales skyrocketed to a fever pitch. This parabolic jump follows four years of very brisk sales and rising profits for the gun industry.

In the last four years Smith and Wesson Holding Corp (SWHC) has risen about 300% and Sturm Ruger (NYSE:RGR) has jumped about 700%. Cabela's (NYSE:CAB), a sporting goods retailer is up almost 1000% since its 2008 lows. Is the parabolic increase in gun sales since the election sustainable?

The American culture involving gun ownership sprang from the need for law and order in a newly settled country. As civilization progresses the duties of law and order are increasingly delegated to government employees, along the line of thinking of the division of labor as laid out by Adam Smith in the Wealth of Nations.

The majority of gun buyers live in the more rural parts of the country. It would be generally fair to say that many people living in rural America feel that their way of life is under attack. Many of the industries that have been the backbones of the rural economy such as timber and mining have seen dramatic decreases over the last few years.

Unemployment rates are generally higher in rural areas as opposed to the more densely populated parts of the country. The poverty rate is about 3% higher in rural America than the more urbanized areas. The average per capita annual income in rural America is about $11,000.

The most popular selling gun in the last few months--the AR-15 currently costs about $1,600, if you can find one. A case of 1000 rounds of .223 ammo costs about $400. That is a total of $2,000 or almost 20% of per capita income for a year in rural America.

Taxes are rising, government programs are being cut back, the rural population is dwindling and moving to the more urban areas in search of employment. Gas prices are high and rising, as are house and rent prices. These are all major headwinds to the gun-buyer demographic.

In the wake of the horrific Sandy Hook shooting, the fear is that gun rights in America will be dramatically restricted. If history is any guide major moves that are politically risky are not done in one fell-swoop but rather very slowly, a little at a time.

An element that should not be ignored in the gun stock bubble debate is the role of institutional money. Numerous pension funds have cut their positions in gun stocks. While it appears that much of the institutional exit from gun stocks is due to political pressures, it is also possible that they are starting to see a top and are booking profits as the individual investors are rushing in, giving the institutions the ability to exit a high price.

I would be starting to exit long positions in gun stocks with the goal of being out shortly after the next quarter's earnings report (which should be a blow-out on the upside). After that, these stocks may be worth looking at for a short position, as more and more gun buyers refocus on getting back to work and earning a living.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.