If you perform a search on this group
<
http://groups.google.com/group/Gmail-Users/search?hl=en&q=inline+pictures&start=0&scoring=d&hl=en&>
you'll find several discussions of people wanting to do this, but the
short answer is that it's not native to GMail, and not easy to
accomplish. There is a wide variety of opinions on this, from those
who are upset, to those who feels that's a good thing (I'm in the
latter).
There is an "Attach a file" link which properly adds your picture as
an attachment, which your recipient can then open to view. This is
the easiest/quickest way to accomplish what you're looking for.