Gold is considered the most precious commodities along with oil. Some people cite gold as the "yellow gold" whereas oil is cited as the "black gold". Gold has attracted the interests of many investors. They will put some of their wealth in terms of gold.
A country will also invest in gold. In mercantilism, which was proposed by Jean Baptiste Colbert (1619-83), precious metals such as gold and silver were regarded as the asset of a country which affected the wealth of a country. It led to an increase in overseas colonies to ensure the supply of limited precious metals. In the gold standard period, the value of a monetary unit will be set at a price to buy and sell gold. The monetary unit of each country will then be linked together to set the exchange rate.
However, currently, most countries do not apply the standard gold anymore. To set the exchange rate of the currency of one country will be referred to the reference currency such as the United States dollar and Euro. In this monetary system, the law of supply and demand will highly influence the exchange rate.
For instance, if the demand of the US dollar is higher than Indonesian Rupiah, the US dollar appreciates against the Indonesian Rupiah. It occurs when Indonesia import more goods and services from the US than export goods and services to the US. The exchange rate is one of many factors that affect the international trade. Two countries can trade goods and services due to the different exchange rate. A country which has a higher exchange rate than another country has more purchasing power to buy goods and services produced by another country.
The US dollar and gold prices have a reverse relationship because gold is used as a hedge against the adverse exchange value of the dollar. Therefore, when US Dollar depreciates, it will take more of the US dollar to buy gold. Many researchers have put their interest regarding the relationship of the exchange rate of the US dollar and gold prices. Sjaastad (2008) found that the movement of exchange rate Euro and Yen against the US dollar has a significant impact on the gold price in all other currencies. Interestingly, the currencies of major gold producer countries do not have a profound effect on the world gold price.
Nair, Choudhary, and Purohit (2015) highlighted the impact of recession toward the relationship between the exchange rate of US Dollar against India Rupee and gold prices in India. They found that after the global financial crisis in 2008, the US dollar and gold prices have an identical relationship because gold prices increased accordingly the hike of US dollar.
This research also was confirmed by Ranjusha, Devasia, & Nandakumar (2017). They also argued that the fluctuation of the exchange rate of US dollar in Rupee was the important factor in fluctuation of gold prices in India. Thus, controlling the exchange rate can stabilize the gold prices in India.
What about the relationship between the US dollar and gold prices in Indonesia? There are two kinds of relationship between the US dollar exchange rate against Indonesia Rupiah and gold prices, which is linear and reverse relationship.
At the beginning of 2018, the gold prices inclined to increase so does the US dollar exchange rate. However, this relationship changed during the second semester of 2018. The US dollar appreciated significantly against the Rupiah, whilst the gold price declined sharply. The reverse relationship between the US dollar exchange rate and gold prices occurs when the US dollar appreciated significantly against Indonesia Rupiah. Thus the exchange rate of the US dollar against Rupiah should be taken into consideration while taking any investment decision in the gold.
Nair, G. K., Choudhary, N., & Purohit, H. (2015). The Relationship between Gold Prices and Exchange Value of US Dollar in India. EMAJ: Emerging Markets Journal, 5(1), 17--25. https://doi.org/10.5195/EMAJ.2015.66