Gold, the case for your portfolio

Last week, gold came down -3.7%. Business news media (FT) is already pondering about the end of the gold bull market. Could that be true? First of all, I am not focusing too much on daily or weekly movements, since they make me dizzy. I'd rather focus on the medium or long term. So what are the driver of gold price in the long run?

1. Gold is used for jewellery
   Strong long term growth of emerging economies will increase demand for jewellery and will strengthen the gold  further.
   
   
2. Gold is used for wealth preservation
   Let's not forget that gold has been used for this purpose over 5000 years, while our (fiat) currencies are existing for couple of decades, at best for 100 or 200 years. Gold supply is difficult to increase (you have to dig a lot), while currencies can be increased easily.
   The increasing probability that Japan, USA and Europe can escape from the mountains of sovereign debt only by diminishing it through the means of inflation, was driving the gold price for the last few months.

Pricing gold is a little bit difficult, since holding it is not generating any cash flow (usual models depend on cash flows). However, consistent with the statements about inflation, you can actually model gold, using the (negative) correlation between the price of gold and real interest rates (= nominal interest rates - inflation):

As you can see, the model is fitting the reality pretty well. So, when inflation will increase massively, real interest rates will drop as a stone, pushing the gold price up.

Thus, your portfolio should include a sizeable portion of gold, probably around 10%. You also might add some gold mining stocks, also depending on your tax regime (the US is taxing gold heavier than stocks, were as gold has a tax advantage in Germany).