AIMS Energy, 6(3): 487–504. DOI: 10.3934/energy.2018.3.487 Received: 18 April 2018 Accepted: 30 May 2018 Published: 08 June 2018 http://www.aimspress.com/journal/energy Research article A three-way analysis of the relationship between the USD value and the prices of oil and gold: A wavelet analysis Basheer H. M. Altarturi1, Ahmad Alrazni Alshammari1, Buerhan Saiti2,*, and Turan Erol2 1 Institute of Islamic Banking and Finance, International Islamic University Malaysia, Kuala Lumpur, Malaysia 2 Istanbul Sabahattin Zaim University, Istanbul, Turkey * Correspondence: Email: [email protected]. Abstract: This study examines the relationships among oil prices, gold prices, and the USD real exchange rate. It adopts the wavelet approach as a nonlinear causality technique to decompose the data into various scales over time. Higher-order coherence and partial coherence were used to identify the lead-lag effect and mutual coherence function among the variables. The results show that changes in the USD exchange rate influence the prices of oil and gold negatively in the short- and medium-term. While in the long-term, the oil price has a negative impact on the value of the USD. Oil and gold are significantly linked and correlated because their prices are determined in USD. The findings of this paper have significant implications, particularly for risk management. Keywords: wavelet; partial wavelet coherence; U.S. dollar value; oil prices; gold prices 1. Introduction Examining the nexus between oil and gold is an established practice among researchers in the field of economics due to the importance of these variables. Oil is considered the primary driver of the economy. Its price fluctuations impact the entire economy. For example, once the oil prices climb, costs increase and reflect negatively on profits [1]. From another perspective, fluctuations in oil prices may lead to variations in consumer spending, leading to a decline in disposable income and 488 increased inflation. To absorb this issue, gold is regarded as a solution for preserving the value as an asset of international reserve portfolios [2]. Bénassy-quéré et al. [3] state that oil and gold, as international commodities, are exchanged in USD which is the dominant currency for international markets. Hence, variations in the USD affect the relationship between oil and gold prices. Numerous studies examine the connection among oil prices, gold prices, and the value of USD. However, this paper differs in three ways: (1) It uses nonlinear causality tests to study the correlation between oil prices and gold prices due to the nature of financial and economic variables. Most empirical studies used linear relationships [2]. However, this method is ineffective because it does not cover certain nonlinear causal relations. Therefore, it is suggested to use the nonlinear method to examine the causality relationships [4–6]; (2) It uses the wavelet method to decompose the data to various time frequencies which enables us to detect the multiscale nonlinear causality relationships between oil and gold. However, most researchers analyzed the time series at their original level using a cointegration which distinguishes two time scales (short and long-term scales). Therefore, it is suggested to use wavelet analysis to examine this relationship [7–9]; and (3) It uses partial wavelet coherence to examine the relationship between prices of oil and gold while excluding the effect of the USD as a common factor between them. This paper examines the nexus among oil prices, gold prices, and the value of USD by adopting wavelet coherences, including partial wavelet. It is organized into five sections including the introduction and conclusion. The literature review discusses the relationship between gold and oil, the impact of the USD on gold, and the connection between oil and the USD. The section that follows explains the methodology by highlighting wavelet coherence and partial wavelet coherence while section four illustrates the empirical findings of this research. 2. Literature review 2.1. Gold vs. oil 2.1.1. Oil price influences gold price Changes in oil price may influence changes in gold prices. According to Le and Chang [2], different scenarios reflect the effect of oil price on the gold price. The first scenario is the effect of high oil prices on the economy. When oil prices are high, it reflects poorly on the growth of the economy of oil importers. Once the economy shrinks, this will push the share prices in stock markets down. Hence, investors will leave the equity markets and focus on the gold market as alternative assets. This scenario reminds us of the dramatic increase in oil prices during the 1970s which consequently led to a long recession in the 1970s in the US and global economy. The second scenario is the effect of oil price on gold price from the revenue generated by oil exporters whereby they use the high revenue from oil sales to invest in gold. Gold is used as a hedge to preserve wealth. Hence, oil and gold prices have a positive relationship where expansion of oil revenue increases the investment the gold market. In the third scenario, high oil prices increase inflation in the economy AIMS Energy Volume 6, Issue 3, 487–504. 489 and gold is considered a well-known tool to hedge against inflation. Once there is an increase in the level of prices due to of the rise in oil prices, this will lead to increased demand for gold which will reflect on the gold price positively. The literature illustrates a relationship between oil and gold prices. Narayan et al. [10] found a cointegration in the long-term among spot prices and future prices for gold and oil. They concluded oil prices help forecast gold prices. Liao and Chen [11] found that oil price return fluctuations influence the gold price returns. In addition, Zhang and Wei [12] found that changes in the oil return ratio reflect the variations of the gold price return ratio. 2.1.2. Oil and gold prices are correlated Another approach defines the relationship between oil prices and gold prices as correlated and affected by common factors. It does not support the idea that one commodity influences the other. Oil and gold are traded in USD, and the fluctuation of this common factor would influence the movement of both commodities in the same direction, e.g., a decrease in the value of the USD could increase the prices of oil and gold. Zhang and Wei [12] found high correlations among the value of USD, oil prices and gold prices. Their research shows that the value of USD causes price changes of both commodities. Others view that the correlation between them is not one of causation. Although the movement of both commodities is within a similar pattern, it does not necessarily indicate that one causes the other. In Turkey, Soytas et al. [13] found that oil price cannot predict gold prices. Once a common stochastic shock hits the economy, Hammoudeh et al. [14] observed that gold prices change first followed by oil prices. From cointegration and causality analysis, Zhang and Wei [12] found that the value of the USD value causes fluctuations in oil and gold prices. 2.2. Gold vs. USD Gold is a precious metal that can preserve its value and is accepted in business transactions. In addition, it plays a significant role in the derivatives markets for hedging purposes [15]. Concerning gold price and the USD exchange rate, numerous studies found a negative relationship between gold price and value of the USD. Considering that gold is priced internationally in USD, a depreciation in the value of the USD lowers gold prices which motivates investors to buy gold to maintain their wealth. This increases the demand for gold and, consequently, pushes gold prices up. On the contrary, appreciation in the USD value drives gold prices to move down, presenting that they move in opposite direction [16,17]. Considering the negative correlation between gold and USD implies that when the major currencies, on average, are appreciating against the USD, gold also appreciates. In other words, gold performs similarly to other currencies. Therefore, when the USD exchange rate depreciates against the main currencies, it means that the USD also loses its value against gold. The relationship would then be a correlation without referring to a causal relationship where the USD exchange rate influences gold prices [18]. Unlike the prior argument which is based on observed reality, Capie et al. [16] identified other reasons such as the significance of political instability and its effect on gold prices. AIMS Energy Volume 6, Issue 3, 487–504. 490 Additionally, when there is an unpredictable economy, gold is a tool to reduce the risk of exchange rate variations and is used to maintain wealth. Capie et al. [16] found a negative relationship among the value of the British pound to USD and gold prices, and between the value of Japanese Yen to USD and gold prices. In addition, Tully and Lucey [19] examined the response of gold spot and future prices to macroeconomic variables and revealed that the USD was significant among other macroeconomic variables that affect fluctuations in gold prices. Since the fall of the Bretton Woods System, gold prices have been more volatile due to the inconsistency of exchange rates [20]. Therefore, gold prices are influenced by the USD exchange rate. 2.3. Oil vs. the USD The USD is used in international crude oil trading which makes the relationship between these variables an interesting study. Gillman and Nakov [1] found strong proof for causality from the price of oil to inflation. They advocate that shocks in oil price are signs of cyclical inflation fluctuations. Research found that the connection between oil price and USD is cointegrated.