[spoiler]Oh I need to make a correction. According to the interview with Del Toro, he indeed left it ambiguous. It's merely his opinion that it's reality. Thus any interpreation is valid.
In that case, I fully side with the idea that the Fantasy was fictional, and inside her head. I see it being more powerful that way.[/spoiler]
[spoiler=The Director]MG: I'm glad to hear you say that. This is the dispute going on among people who have seen your film. Was Ofelia in her fantasy world? Was it a real world? I keep saying such questions pose a false dichotomy.
Del Toro: Yes, of course. And it's intimate. If the movie works as a piece of storytelling, as a piece of artistic creation, it should tell something different to everyone. It should be a matter of personal discussion. Now objectively, the way I structured it, there are three clues in the movie that tell you where I stand. I stand in that it's real. The most important clues are the flower at the end, and the fact that there's no way other than the chalk door to get from the attic to the Captain's office.[/spoiler]
And something someone else on another discussion thread has said
[spoiler=Gotariverfenixexp]That said, there's definitely room to interpret it either way. We see Ofelia reading a book in the beginning. Rather than setting the stage for a legend, this can literally be interpreted as the story at the beginning of the film being the same as the story she's reading in the book. The best support for this is that Ofelia is given a blank book. She has to write her own story to escape her harsh reality. For me, though, the most heartbreaking part of the entire movie is when the captain turns the corner and sees Ofelia talking to no one. That single shot is the best evidence I see for the fantasy elements being imagined.
I like that it can be interpreted either way, though. That last scene has Ofelia talking to an imaginary creature, surrounded by true evil and not able to escape it, and so she dies. This easily could have turned into some kind of lame moral, but instead she is smiling. Even if the fantasy sequences were fake, Ofelia dies with a smile. In HER mind, she's a princess going to live with her family. Even if what we've seen isn't "real" to our world, it's "real" to her, and I think that's the point.[/spoiler]
I basically agree with him.