Gun Sales: Pitfalls of Fear Trade Speculation

By Joshua Enomoto, Founder of and contributor
Given the decline in moral and social order that often accompanies economic uncertainty, many individuals and families are turning to firearms as a hedge against an increasingly violent society. Despite recent tragedies involving the horrific misappropriation of firearms, gun sales have soared over the past few days as concerned buyers fear for further restrictions on Second Amendment rights. This behavioral pattern is by no means surprising as mass shootings in the past have led to speculative purchases of both firearms and ammunition, sending prices rocketing into the stratosphere. Hence, the irony of so-called “gun control:” the fear that gun rights will be controlled by an ever-enlarging government gives rise to more gun owners. For those not inclined to a physical weaponry perspective have been known to invest in shares of gun manufacturers and recent trends have shown a massive upswing in this sector. The question is, will the fear trade be a viable one going forward?

Let’s take a look at Smith & Wesson Holding Corp, or SWHC:
Shares of Smith & Wesson have plummeted since the school shooting, losing more than 10% of valuation. Technically, the price of its shares fell below the first line of a series of parallel (and inclining) support lines. Not only that, the current price sits right at the second line of support ($8.10) and is precariously close to the first of three horizontal support levels ($7.50). Gravity and momentum suggest that a re-test of the $7.50 mark is more likely than not. For SWHC, the fundamentals will not be supportive of immediate higher prices.

Why? Despite record breaking gun sales, this surge is a one-time event that only benefits individual retailers. Investors need some measure of predictability and a forecast of future earnings and growth: mass shootings are NOT it. Keep in mind that restrictive gun laws will only have a positive effect on point-of-sale transactions to the end user, which is commonly know in retail vernacular as “sell-through.” When investors weigh in on stocks such as SWHC, they are analyzing a proposed law’s effect on “sell-in,” otherwise known as “B2B” (business-to-business) sales. In this case, if restrictions criminalize ownership of profitable product-lines, such as .357 Magnum revolvers, it would negate the current and future ability of Smith & Wesson to grow and post profits.

Given the unspeakable crime that occurred last week, it is safe to say that this nation is in a state of shock. President Obama will aggressively attempt to impose broad limitations on the right to bear arms and this is fundamentally negative for SWHC as future generations of gun owners will face increasing difficulties to practice their civil liberties.

As such, a shift in the cultural archetype of America may be occurring, one that makes investment in this sector a thorny proposition. While the firearm industry certainly has a legitimate reason to exist, the left-leaning mainstream media will exert their hegemony against everyday citizens. For SWHC, political and cultural pressures may see its shares falling to the $6.50, right above the last line of parallel support, before a stronger move up begins. If ownership in a gun company is still desired, a more conservative and less volatile option could be Sturm Ruger & Co.

Here is the 3-year weekly chart for Ruger, or ticker symbol RGR:

As you can see, RGR has been trading in a well-defined trend channel for the last few years and is devoid of the “spikiness” of SWHC, which makes Smith & Wesson vulnerable to sharp corrections. Nevertheless, Ruger has also suffered in the wake of bad publicity and it share price is currently trading at the lower range of the aforementioned trend channel. Due to fundamental pressure, RGR is at risk of re-testing previous support strongholds, at $37.50 and then at $32.50. Failure to hold $32.50 would be very bad for RGR, as the next line of horizontal support would be around $28.

Is there an investment opportunity with gun manufacturers? Yes, but this time, it’s not a simple matter of buying on the cannons and selling on the trumpets. One must first differentiate between investment demand and retail demand (related but NOT the same) and second, regardless of personal political affiliations, there must be an appreciation of how current cultural factors can stymie the fundamentals of an otherwise profitable company.