Side Street

Staring Down the Business End of the Firearms Trade

Posted on 12/11/12 - 11:37 AM EST

The recent focus on increasing gun sales in America is naturally bound up with all sorts of political and social undertones. For the past three years, firearms maker Sturm, Ruger & Company (RGR) has appreciated more than 500%. The other major firearms maker, Smith & Wesson (SWHC), began to make its move roughly thirteen months ago.

Over the past week, though, both stocks have been hit with aggressive bouts of selling. Just as the national media (and many non-market types, in general) caught on to this theme, the stocks sold off, particularly after Smith & Wesson's earnings last week. However, the thesis of more Americans yearning to purchase and possess firearms appears wholly intact.

The issue then becomes whether this is a mere shakeout of latecomer, momentum longs, or instead the end of a multi-quarter bull run.

Since SWHC's earnings served as the excuse or catalyst for the sell-off, depending on your perspective, let's look at an updated weekly chart first. You can see a clear support trendline dating back to the beginning of the uptrend in late-2011. Currently, price is flirting with breaking this trendline. This trendline is quite steep and blatantly obvious. So, I would not be surprised to see it breached imminently.

However, I suspect this trade requires thinking to the next level, given how many traders and casual market observers seem to now be on to the fact that firearms makers are enjoying a bull market of their own (More on this after the first chart, below).

As a result, I would view a breach of the support trendline as a probable shakeout that sets up another buy point in this bull run.

To support that idea, let's now look at the monthly timeframe. Note how critical the $7-$8 area breakout was for SWHC this year. The buy volume further supports the bull case, with buyers of size presenting themselves and sustaining the effort. With this in mind, the thesis is reinforced that another buy point is looming for patient market players.

Of course, that thesis naturally begs the question of when and where to look for that buy point. Underneath the monthly chart below, you will find jaw-dropping seasonality statistics (courtesy of The PPT algorithm and service here at iBankCoin) for Smith & Wesson. You are talking about a stock that, when it hits, hits incredibly big in January, February, and March. And, as you can see by the percentages, more often than not it hits. Mind you, there are thirteen data points here, just about all of which occurred during a secular bear that began in 2000. Hence, the January-March (even April is very strong) performance is all the more impressive.

Building a position into further weakness this month, but not if price loses $8, makes sense here. Note that the stop-loss discipline to get away from the stock if it cannot turn that prior long-term resistance into current support is necessary in order to justify the risk/reward profile of the evidence outlined above.

THE BLOG: http://ibankcoin.com/chessnwine/2012/12/10/staring-down-the-business-end-of-the-firearms-trade/