What Stimulated the Gun and Ammo Market?

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Since Obama's
victory in November, Smith and Wesson and Ruger, the only two publically
traded US gun makers, have experienced major increases in their
stock prices. Ammo manufacturers are running 24/7 attempting to
keep up with demand. Military-pattern semi-automatic rifles, including
AR-15's and AK-clones are expensive, stocked-out, or both. Are these
price increases "gouging," as some would say, or are they
a natural response to the forces of supply and demand? If these
prices are elevated over normal conditions, will they continue to
soar upwards? To both questions I say, "No, there is no gouging,
prices will probably fall in the future."

Ruger and S&W
share prices from Election Day to the present:

Since mid-late
2008, the gun market has bifurcated into two separate and distinct
segments. Understanding the difference is very important. Historically,
hunting rifles and sporting shotguns have made up the lion’s share
of civilian gun sales. Smith and Wesson (SWHC) attempted to capitalize
on this trend in 2007 by purchasing Thompson/Center arms (a niche
upscale maker of muzzleloaders and single shot hunting rifles) and
importing a line of high-end Turkish shotguns and rebranding them
as S&W. Unfortunately, their timing was proven to be pretty
bad. Since the stock market fell into freefall last October, sales
of hunting rifles, sporting shotguns, and accessories for the like
have fallen off dramatically. Hard numbers are difficult to come
by, but speaking to dealers at the 2009 SHOT (Shooting Hunting Outdoor
Trade) Show, sales have fallen dramatically. Hunting as a segment
is shrinking, and rifles are a long-lived asset. So hunting rifle
demand has cratered.

Now, onto
the "booming" segment of the gun market.

Three sub-divisions
are worth highlighting:

  1. Semi-automatic
    handguns and accessories (magazines mostly)
  2. Military-pattern
    semi-automatic rifles (AR-15′s, AK-clones, etc.) and accessories
    (magazines and parts)
  3. Ammunition
    and ammunition components

Since it became
likely that Obama was going to win the election, groups like the
NRA and GOA (Gun Owners of America) have been highlighting past
statements by Obama and his Attorney General, Eric Holder, suggesting
that while in office he would ban and regulate guns much more severely
than previous administrations.

Highlighted
proposals include: A 500% ammo tax, a ban on all military-pattern
rifles, a ban on magazines with a greater than ten round capacity,
federally licensing all gun owners and registering their guns. As
a result, gun shows, ranges, military bases, shooting matches, online
forums, etc., have been a cacophony of people fueling the fear of
an upcoming ban. Gun owners, who have never seen, much less held
a military-pattern rifle, are going out and purchasing $1200 AR-15′s,
a pile of 30-round magazines, and cases of 5.56mm ammo. Gun owners
that already own such a rifle are going out and purchasing all the
military pattern rifles they think they will EVER want/need. The
presumption, of course, is that the ban will be similar to the federal
Assault Weapon Ban of 1994 or the California ban of 2000 that grandfathered
all preexisting guns. The AWB of 1994 in particular, because transfer
after the ban was legal, caused prices for grandfathered guns to
double or triple over their post-ban counterparts. S&W was smart
to introduce the M&P line of pistols and rifles, which have
been selling VERY well since November.

Ammo prices
from 2003–2007 tracked the run up in the price of lead, copper,
and brass.

Following
the major correction of lead, copper, and zinc prices in 2008, one
might have assumed that ammo prices would have fallen as well. Wrong.
Instead, ammo prices have soared even higher. Last year, Q3131 (Winchester's
standard 5.56mm commercial ammo) could be found as cheaply as 28
cents per round. Now prices have risen to roughly 50 cents per round.
Other military calibers, 9×19, 7.62×51 NATO, 7.62×39, 5.45×39, have
also increased substantially, some having doubled or tripled in
price. Pistol ammo, while not affected to the same extent of rifle
ammo, has all but vanished from the shelves of almost every major
retailer in South Florida. Primers (one of the key requirements
to manufacture ammo) have increased in price by about 50%, and their
availability has also declined.

The questions
I have:

  1. Are these
    trends sustainable?
  2. When will
    these markets return to normal?

To answer these
with certainty, I would need a crystal ball regarding policy in
the Obama administration. I could definitely be wrong on this, but
given the continuing economic catastrophe, gun control is probably
the last thing on Obama’s mind. The Democrats have not forgotten
1994, the year they were thrown out of office for voting yes on
the Assault Weapon Ban. Also, in 1994, gun ownership was very different
than in 2009. In 1994, it was MUCH easier for the politicians to
split the gun owners down the middle into “hunters and sportsmen,”
who owned bolt-action rifles and skeet guns, and “gun nuts” who
owned “crazy assault weapons." The latter group was small and
easily marginalized. Eric Holder, the new Attorney General, has
stated on several occasions his desire to enact draconian new
gun control laws
. Nancy Pelosi, on the other hand has shot
down
the idea, for now.

These days,
the two groups are considerably more mixed. The AR15 (the civilian
version of the M16) is the dominant rifle in ALL forms of rifle
competition outside of some niche sports (benchrest, biathlon, etc.).
Remington, the hunting rifle maker (owned by Cerberus
Capital
), has rebranded Bushmaster (another Cerberus portfolio
company) AR-15′s as hunting rifles. These days, the AR-15, far from
being the choice of militia members and wingnuts, has become the
best selling rifle in America for hunting, self-defense, competition,
and general collecting. So trying to outlaw them would be political
suicide for politicians from either party. Also, the Supreme Court
has stated in the 2008 Heller decision that the Second Amendment
protects an individual right to keep and bear arms, so even if a
ban were enacted, it would be unlikely to hold, in my opinion. Clayton
Cramer is probably one of the best equipped to discuss the jurisprudence
on the matter, but the wording of the Heller opinion makes a ban
on rifles that are common and not unusually dangerous unlikely to
stand up.

If we assume
that there is no second assault weapon ban, where does that fact
get us? Well, let's look at the microeconomics of supply. Many start-ups,
consisting of little more than a couple of machinists and a CNC
mill have begun cranking out serialized rifle components. Many have
bought expensive and unique tooling; those people are going to want
to stay in the business until the price of parts falls below marginal
cost. While I don’t have precise estimates on costs, I do know that
AR-15 lower receiver forgings can be purchased for $35 dollars and
the finished product sold in 2005 for $90 dollars and now sells
for $175–300 dollars. To me, this suggests that prices may
have a long way to fall to a new equilibrium. Regarding ammo, supply
hasn’t responded as quickly. Ammo production is a capital-intensive
business and the supply of newly manufactured ammo competes with
foreign ammo and foreign military surplus. Supplies of foreign military
surplus ammo seem to be drying up. In addition, most ammo companies
are running 24/7 to meet demand for military contracts. There are
some signs supply might be increasing: Black Hills (a prominent
producer of match ammo) has bought a 65,000SF facility to triple
capacity
. Handguns are considerably more differentiated than
military-pattern rifles. No significant startups can be expected
to enter because of the present high demand. The big names, S&W,
Ruger, Glock, Sig, etc. don’t seem to be dramatically adding capacity,
as they probably expect the bump in demand to be temporary.

What about
demand for all these products? I think this will be crucial. Can
gun-ban anxiety panic shopping be sustained for four (or maybe eight
years)? No, and I think we’re beginning to see signs of cracking.
Having spoken to gun owners, gun dealers, gun show exhibitors, and
other people in this industry, I find that the undercurrent of what
people are beginning to say is, “Okay, I have what I need.” For
a gun owner of modest means, that means an AR-15, 10 magazines,
a quality handgun, 10 magazines, and a few thousand rounds of ammo
for each. A key point to remember is the backdrop of this is still
the ongoing depression; consumers are cutting back, de-levering,
selling their knickknacks. When people fear losing their job, $450
dollars for a case of military surplus 5.56mm becomes substantially
less attractive, especially when it sold for $125 just a few years
ago. Most consumers will likely build their stockpile, and if they
lose their job, be forced to divest some of it to make ends meet.

For the change
in ammo demand to be sustainable, gun owners would have to be shooting
thousands of rounds per month, which aside from a few thousand competitive
shooters, is unlikely. Military demand for ammo has been consuming
the majority of domestically produced military caliber ammo. Currently,
Olin, Prvi Partisan, IMI, Black Hills, and several other companies
are producing flat out to meet military demand. As military contracts
get priority, this has squeezed supplies to the civilian market.
Is this sustainable? Possibly, but unless Obama is planning on invading
Pakistan, demand should fall as we disengage from Iraq. However,
if Obama proves to be a hawk, this trend could continue.

Based on the
preceding, I think that increasing supply and decreasing demand
will alleviate the scarcity and reduce the price of most military
pattern weapons and ammo. However, there are risks that events could
complicate this analysis. The most obvious possibility is that a
ban DOES come into effect. But again, this would likely cause a
temporary hyperbolic rise in market prices, but a permanent curtailment
of demand for the products of S&W, Ruger, Bushmaster, DPMS,
Remington, etc. Another possibility is that the increased attention
to guns due to crime and Obama represent a secular shift in the
attitude of the public. Indeed, there are signs of this. Florida
has a backlog
of 93,000 citizens applying for concealed carry permits. Tennessee
has also experienced soaring
gun purchases and permit applications. Concealed carry permit holders
tend to differ from hunters in their consumption patterns. Hunters
tend to buy bolt-action rifles, concealed carry permit holders purchase
small handguns. Concealed carry permit holders also tend to purchase
“tactical” training and equipment (rifles, shotguns, etc). Concealed
carry permit holders also tend to be more politically active than
hunters. Once this “new batch” of gun owners is armed, their demand
for guns will fall along with their demand for fancy cars, RV’s,
vacations, and other consumer discretionary purchases.

I believe I
have laid out a case that suggests that the torrid boom in the gun
industry may be a frictional blip in response to the Obama election,
similar to IT spending in preparation for Y2K. Eventually, however,
increasing supply and decreasing demand will put downward pressure
on prices and backlogs.

March
5, 2009

R. Brent
Mattis, MBA [send him
mail
] is a finance professional living in the South Florida
area. He is an IPSC competitor, NRA Pistol Instructor, and advocate
for the shooting sports.

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