Most people would consider Claypool Hill, Virginia, a typical U.S. town.

It is home to 1,912 folks. It's situated about halfway between Lexington, Kentucky and Richmond Virginia.

Unemployment is just under 7%. The town's crime rate is right in line with national averages according to FBI statistics. There's a Best Western there too.

It would seem like the most average place in the country…unless you stop by Trader Jerry's at the corner of Taylor and Honeyrock. Jerry Cochran, proprietor or Trader Jerry's, says he's experienced a “big increase” in business. He says he's facing a significant “shortage” of merchandise while his customers are “hoarding” all available supply.

Sounds like Jerry's doing pretty good business. What does Jerry sell, you ask?

He's not in the swine flu vaccine game or anything like that – although that would have been good.

He doesn't sell gold coins either – that “micro-bubble” where coin dealers were getting 15% to 20% premiums on their inventories has run its course as well.

Jerry sells guns and ammo. And right now Jerry's business is booming. A surge in demand has caused gun prices across the country to nearly double. When it comes to ammo, Jerry has run out - just like thousands of others.

The guns and ammo boom is alive and well. And if we pay close attention, it's easy to see where the real opportunity is. As usual, it's not where most folks are looking.

Gun Stocks Making a Bang

The guns and ammo boom is no secret. Ever since the first Wednesday of November 2008, guns and ammo have been flying off the store shelves.

The sales surge has unleashed the creative headline makers at virtually all media outlets.

ESPN claims, “The Ammo Boom is No Dud.”

The Bluefield Daily Telegraph states, “Ammunition Shooting Off Retailers' Shelves.”

The Lawrence Journal says, “Worried Gun Owners Trigger Shortage in Bullets, Rise in Price.”

They aren't overhyped reports just to make “news” though (swine flu, anyone?). They are as real as ever. The leading manufacturers of ammo back up the statements.

A spokesperson from Remington said, “We're working overtime to produce ammo, but right now we cannot meet the demand. Our only option would be to add more equipment, but that's not an immediate solution because it would probably be a year out before we could add significantly to the amount we're producing now.”

It's not just ammo though. Gun sales have been surging too. Gun manufacturer Sturm, Ruger, & Company (NYSE:RGR) said its sales climbed 81% in the last quarter of 2008. There's no sign of a slowdown anytime soon either.

There are quite a few catalysts for the shortages as well.

On the demand side of things, most of it seems to stem from expected government regulation. Many gun owners expect new bans, a new level of background checks, limitations on how much ammo can be purchased or stored, and/or a five cent per round tax on ammo.

Remington's media liaisons added, “Our operations are running 24 hours a day, seven days a week. Our team is literally working around the clock.”

The whole shortage has paid off handsomely for gun and ammo manufacturers. Shares of Sturm, Ruger & Company and Smith & Wesson (NASDAQ:SWHC) have bounced back 175% and 300%, respectively, since hitting lows for the year in November.

Whether you agree with the proposed gun-control policies or whether they will be implemented doesn't really matter here (most readers will probably know where a U.S. veteran stands). Perception is what matters here. Perception is reality. And the prevailing perception of the future has gun owners buying more guns and stocking up on ammo.

If we pay close attention, the herd of gun owners can teach us a lot. They're also showing us where the real gains in guns and ammo stocks will be had.

Guns and Greed: Striking Similarities

As you can tell from what's going on in the gun world, this is a classic panic situation.

Producers simply can't ramp up production overnight. Increased demand – regardless of the cause – has sparked a “run” on gun shops and ammo dealers across the country.

Dawn Demetris-Stucker, a co-owner of ammo outlet On Target, says, “Typically, when people feel they're short on ammo, they would buy one box. When they feel there's a shortage, like we've seen recently, they want to buy five boxes.”

This is the perfect example of the “buy now or you'll never be able to get it” mentality. Gun owners willingly pay an inflated price for bullets now because they fear they won't be able to buy more ammo again in the future. And if they do see an opportunity, they see increased taxes and limits on the amount they can purchase.

Does this type of situation remind you of anything we've looked at lately?

History Repeats…Again

Do you recall my friend “Peter”? He's the coin dealer who sells “twice as many gold coins when gold hits $1,000 an ounce than he does when gold is under $900 an ounce.

Or every other stock market bubble in recent memory. There are plenty of examples of “got to buy today or I'll never get to buy.” For instance, we had those tech stocks which earned “new economy” valuations. Agriculture stocks who soared after an over-publicized rice shortage in a few countries. Then there's oil, mining, China, India, and on and on.

They all reached the “panic buying” stage. This “panic buying” stage always comes to an end eventually. Now, I think it's reasonable to expect the same thing to happen with guns and ammo shares.

With stories about surging guns sales featured on 60 Minutes and other prominent news outlets, it's usually a good sign an end to the run is near.

First a short downtrend begins. A lot of folks let greed and emotion take over their decision making process and they jump on in with the “buy on dips” crowd. Then, after a short reprieve, things really start to fall.

The “Panic” Stage of the Rally

We go through these cycles all the time. Regrettably, most average investors never learn. At the Prosperity Dispatch we strive for the extraordinary though. That's why we try and take a step back and look at what's actually driving the markets.

In this case, its' clear the market has some very great expectations for the guns and ammo sector. Aside from knowing what great expectations normally lead to, we can see most of the run in guns and ammo stocks has been driven by a (essentially) one-time event. There hasn't been any focus on the reality of what this sudden, and unsustainable, surge in demand will do to long-term earnings (read: very little impact). Combine all that and you've got a good indication the party here is about to end.

More importantly, this situation gives us a glimpse into how this rally will likely play out.

It's no secret we're in the middle of a very strong rally. It's one that just keeps going and going. As usual, many observers are still perplexed. The really big money hasn't bought in yet. Most commentators are still outwardly sure this is a (insert - head-fake/sucker's/bear market - here) rally with a limited life. “There's nobody buying stocks” they would have us believe –the market tells us otherwise though.

Every sign points to this rally not lasting forever. We know we're still in the latter part of Stage 2 or the early parts of Stage 3 of this rally. Once the majority of folks believe we're in the clear and start buying aggressively “because they'll never see prices this low again,” then it'll be time to get ready for the downtrend.

Until then, it's best to buy on the uptrend with a plan of action in place to protect against the downfall when it does come. For traders, now is also a good time to search out highflying sectors which are benefiting from one-time events (law change, one-time demand increases from stimulus package, etc) and get ready to bet against them.

So, although we may be happy Jerry and his colleagues are benefitting from the “best times decades” to be in the sector, history shows “panic-buying” usually ends the same way. And that's the same for bullets, houses, Beanie Babies, and stocks too.

Good investing,