Gold investors count on the yellow metal providing a safe haven during times of trouble, and with reports of U.S. fighters jets deploying to Poland amid Russian military exercises near the Ukrainian border, gains for gold would have been expected, especially with the Dow off more than 200 points. But gold's gain was actually small compared to yesterday's advance. April gold futures settled up just $1.90 per ounce to $1,372.40, and although spot gold fared somewhat better, SPDR Gold Shares (NYSEMKT:GLD) rose just 0.3%. Silver fared even worse, with May silver futures actually falling $0.16 per ounce to $21.20, sending iShares Silver (NYSEMKT:SLV) down half a percent. Platinum and palladium were little changed as well, even though mining stocks were up sharply as the Market Vectors Gold Miners ETF (NYSEMKT:GDX) climbed 2.5%.


Today's Spot Price and Change From Previous Day


$1,373, up $6


$21.22, down $0.11


$1,472, up $4


$773, up $1

Source: Kitco. As of 4 p.m. EDT.

Image sources: Wikimedia Commons; Creative Commons/Armin Kubelbeck.

How far can miners climb?
One aspect of the recent rebound in gold is that mining stocks have dramatically outperformed bullion prices. So far this year, the return of the Market Vectors ETF is roughly double what the SPDR Gold Shares have returned. To some who aren't familiar with the business model of gold mining, that seems like a possible sign of excessive gains for miners, which leads those investors to conclude that mining stocks' gains aren't sustainable.

But when you look historically, you find that these disparities are common in both directions. For instance, in 2013, mining stocks plunged much more than bullion prices, with even major companies Goldcorp (NYSE:GG) and Barrick Gold (NYSE:GOLD) falling 40% to 50%. Similarly, during the long bull market that saw gold prices soar from below $300 to $1,900, many gold-mining stocks produced gains far in excess of the returns for bullion investments.

One key reason why miners tend to outperform bullion in rising gold markets is that miners' business models are inherently leveraged. As a simple example, if gold prices are at $1,300 per ounce and a miner's all-in cost of production and other expenses is $1,200 per ounce, then the difference of $100 falls through to the bottom line. But if gold prices rise by just $100 -- less than 8% in our example -- then this theoretical miner's profit doubles. Since stock prices tend to follow earnings, mining stocks magnify changes in gold prices in either direction.

Yet what you must remember about gold miners is that, counterintuitively, the miners with the best fundamentals -- high margins and low production costs -- won't necessarily climb as much as weaker, higher-cost miners. Again, in the example above, say a high-quality, low-cost gold miner has all-in total costs of $800 per ounce. In that case, a rise from $1,300 to $1,400 for gold prices would only boost this miner's profits by 20% -- much less than the 100% growth of the higher-cost miner. Yet as we discovered when gold prices plunged last year, higher-cost miners run the risk of insolvency and having to close down operations if prices fall below their production costs.

If prices continue to climb, then Goldcorp, Barrick, and other major mining stocks will not only see profits on their current production rise but also look at taking on more exploration projects. The resulting rise in revenue and profit could sustain a much larger increase in mining share prices than we've seen so far in 2014.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.