I was asked this very question a couple of weeks ago by a friend of mine (not that I actually have gold currently in any of my portfolios, but that's part and parcel of being a more active trader).
Having a long position in physical gold possibly isn't necessary for those managing smaller portfolios, but for larger portfolios there is a really strong argument behind it. In the current climate, where major indices are reaching up towards the inflation adjusted levels we saw before the last crash, margin borrowing levels are back at pre-2008 crash levels and where political tensions are steadily increasing across the globe, having a strong hedge against global economic unrest is essential to preserving personal wealth.
One of the first problems that many westerners have with understanding gold, is that we have a tendency to believe that gold is a speculative asset driven by COMEX futures and ETFs and we ignore the fact that the biggest stock of gold held worldwide is in jewellery (mostly by Indian households who own around 18,000 metric tonnes of gold in total). The largest demand annually is still in jewellery and the largest annual geographic demand remains in India and China.
This is an important demand point to remember, because we can compare movements in physical premium prices in India and China against the leveraging levels in the COMEX futures and ETF redemptions to determine major changes in the gold price. For example, back in January 2014 when we saw these speculative gold indicators, we could have deduced that the gold price was unlikely to fall below $1200/oz as the gold premiums in China and India were still very high at that point. In effect we saw a transfer of western sellers to eastern buyers.
Excluding the jewellery markets, industrial demand is another important factor to remember as it amounts to a steady 10-12% of the world's gold demand, although when gold has been high in its price range there has been a change in many cases towards copper for the production of these semiconductors.
In terms of supply, the most important point for me is that when we analyse the gold price we need to remember that gold miners produce about 2,600 tonnes a year while gold recyclers recycle about 1,600 tonnes a year. This relatively low supply and low volatility in terms of supply is one of the reasons why gold has a generally low volatility.
A really big point we have to remember is that in terms of the global total assets under management, which is estimated as being anywhere from $120-150 trillion, gold still only amounts to between 0.5-1.0% of that total pot, so we can ignore arguments that gold is a done trade.
Other very strong factors behind gold are its uses as an inflation hedge (over the last 30-40 years it has out-performed US CPI inflation in periods of high inflation), a hedge against currency debasement and its potential use as a monetary quasi currency.
To sum up my like of gold, the number one reason to have gold in a long term portfolio is because it has very good characteristics to hedge against bad beta in high sigma events. The World Gold Council ran a study when they took a wide range of credit crunches and ran portfolios with and without gold and in only one crash did gold not benefit the portfolio. So, it effectively reduces current risk, but also hedges your tail-risk levels - it defends against unforeseen risk.
All the best,
The Masked AIM Trader
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