Governments have spent trillions of dollars to revive the international financial system, arousing concern that these near-term palliative efforts may have the unintended consequence of enervating the global economy in the long run. Given this uncertainty, investors have taken a renewed interest in gold, propelling the metal’s spot price to new highs. This month we spoke with Rachel Benepe, one of the new co-managers of First Eagle Gold (SGGDX) who took the helm in the wake of the departure of Jean-Marie Eveillard, about the role of gold as a hedge against portfolio risk.

In the wake of the huge run in prices, should investors still buy gold?

Gold is the best insurance against unforeseen events and the ultimate hedge.

We’re in an environment where there’s a broad understanding that gold can operate as insurance; from individual investors to central banks seeking to maintain or add to their gold holdings, the number of participants and the amount of activity in the gold market has exploded.

Generally speaking, it’s a tumultuous time for financial markets; the unprecedented involvement of central banks and governments around the world increases the potential that today’s policy actions will have unintended consequences down the line.

From our standpoint, buying gold as insurance made sense before and makes sense now. Concerns about inflation have raised awareness of gold’s defensive qualities, but the precious metal is the ultimate insurance against any event or risk that’s difficult to hedge.

Is that what’s driving China’s central bank and others to add to their gold hoard?

A lot of investment in gold is driven by a lack of confidence in competing currencies. The value of an ounce of gold is readily identifiable, so it’s viewed as the ultimate substitute currency.

If you’re the Chinese, or anyone else that holds a lot of US dollars, and you’d like to diversify your holdings, your choices are gold or other paper currencies that may run into some of the same issues as the US dollar.

At the end of the day, you have a choice between two forms of mattress money: a fiat currency or gold bullion in a vault. In this environment, where there’s a lack of trust in what other central banks are doing and concern about the potential consequences of current monetary policies, hard currency is the most attractive option.

Both everyday investors and central banks are worried about fiat currencies. If you look at a basket of currencies going back to 1791 and compare buying that basket of currencies with gold or US dollars, gold maintains its value over that period; since Franklin Delano Roosevelt abolished the gold standard, the dollar has lost 95 percent of its value.

News reports suggest that miners aren’t producing enough gold to meet demand. What role has that played in the upsurge in gold prices?

There is a scarcity factor to gold. Including proven and probable reserves, there’s more gold above ground than below, and mine production has declined.

But there are two factors that drive demand and, ultimately, price.

In a benign environment where people aren’t worried about the financial markets, jewelry is the primary source of demand. But when jewelry demand grew in the 1990s, it didn’t influence prices dramatically.

Investment demand helps to drive the price up because investors are hoarding gold and there’s less float. Today we’re in an environment where central banks aren’t sellers, but an increasing number of investors are purchasing physical gold.

And gold is a scarce asset. Every ounce that’s ever been mined can fit into two Olympic-sized swimming pools. As more people invest in gold and there are fewer gold ounces available on the market, gold prices will go up.

There’s a supply and demand component to gold prices, but most investors focus on the demand side.

Is the rally in gold prices sustainable?

We don’t forecast the price of gold because we view it as a form of insurance: If gold’s doing well, other assets are likely to underperform; if gold isn’t doing well, your equity portfolio is likely doing very well. We usually don’t take a stance on where prices are headed.

That being said, there are a few market trends that investors should keep in mind. First, Barrick Gold Corp (NYSE: ABX) is active in the market because it’s adjusting a very large hedge book. And central banks are reluctant to sell their gold holdings. Without question, gold investments continue to attract a great deal of money.

Should investors hold bullion or buy stock in mining companies?

Because we view gold as a form of insurance, we prefer the safest gold investment–gold that we have in our vault, gold that’s free of mining risk and accounted for.

At the same time, we recognize that gold bullion isn’t always the cheapest way to access this insurance policy; we use a proprietary model that examines a mining company’s proven and probable reserves and the total cost of extracting those ounces from the ground. The model then compares these factors to spot price of gold. If there’s a significant margin of safety between reserves and the spot price of gold, we invest in that company.

Absent those opportunities, we invest in bullion.

Would you recommend that individual investors maintain a mix of bullion investments and gold-related equities holdings?

It makes sense to have a mix of both bullion and gold-related equities; the key is determining the cheapest way to add gold exposure. Outside of owning a gold fund, the easiest way for individual investors to gain exposure to physical gold is SPDR Gold Trust (NYSE: GLD), but it’s unclear if that vehicle is 100 percent physical gold 100 percent of the time.

That being said, mining presents a lot of risks and requires huge amounts of capital, so your safest investment is probably the gold out of the ground. But equities also offer leverage to gold prices, and sometimes a mining stock’s valuation doesn’t reflect the current gold environment.

Are there any miners whose stocks appear attractive from a valuation standpoint?

Because we own gold as insurance, we prefer to own names that currently produce gold. We also look at names that are building out mines and have a production plan in place. A company that makes a great discovery but doesn’t plan to build it out offers little in the way of insurance–in the ground, those ounces are worthless.

We recommend striking a balance between junior, intermediate and senior producers. It’s a rare occasion, indeed, when one of these groups appears more attractive than another; stock-picking acumen and a corresponding sensitivity to individual situations are essential to investing in gold.

Today South African companies appear cheaper relative to spot prices. By and large, these firms operate fixed-cost businesses whose revenues are more leveraged to gold prices than those of producers in other parts of the world.

Of course, that leverage has both an upside and a downside. But those names are still trading at levels that provide a sufficient margin of safety.

How much of their portfolio should investors allocate to gold?

First Eagle’s non-gold funds have always invested at least 5 to 10 percent of its assets in gold; a gold position below 5 percent doesn’t influence the portfolio in a meaningful way, while a position in excess of 10 percent suggests that the manager is making a speculative call on gold.

If gold prices were to go up five times, the rest of your portfolio probably isn’t doing very well; with a 10 percent gold target, your portfolio has at least 50 percent downside protection.

What’s your best piece of advice for investors over the next 12 months?