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:

Semi-automatic handguns and accessories (magazines mostly) Military-pattern semi-automatic rifles (AR-15’s, AK-clones, etc.) and accessories (magazines and parts) 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:

Are these trends sustainable? 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