November 28, 2008 9:43AM

India, Gold and Oil

By Ray Hennessey

Indian stocks, at least the ones that trade here in the U.S., largely shrugged off the terrorist attacks in Mumbai. Surprisingly, so have commodities -- and that should tell you how inefficient the markets have been lately. Don't underestimate the impact and future risk the attacks represent.

One would expect the "right" trade on the India attacks to be two-fold: long gold, short oil. Oil should suffer because the attacks should impair growth in India -- one of the countries that received the most blame (or credit) for the run up in crude prices earlier this year. Remember the pitch? Demand from India (and China) accounted for the rise. If the Indian economy is indeed hurt by these attacks, that dampens demand even more.

Gold gets more attractive if you think that the terror attacks are sign of things to come (or a reminder of the real security risks this world faces). Gold is a safety play. It is real. It is valuable. It doesn't disappear like paper capital.

The trade in both gold and oil have been muted somewhat by the recent rise in the dollar and the fear of deflation here in the U.S. But gold could shoot up and oil collapse if the attacks are followed up by others or if they spark more tension between India and Pakistan. Remember: the early read on this is that the attacks were carried out by Islamic terrorists hitting Western, Hindu and Jewish targets. And the recent talk that it was perpetrated by what Indian officials will call only "foreigners" suggests India's government strongly suspects Pakistani involvement.

The markets have always (ignorantly) discounted the tension in that region. There is a real chance that these same tensions come front and center now, with the uncertainty of the new Obama administration's response to the conflict thrown into the mix for good measure. Look for gold and oil prices to be the proxy of how this conflict progresses.