I was talking with a colleague a few weeks ago and she wondered aloud whether the economic and political chaos in Italy — mainly the result of Europe’s ongoing sovereign debt crisis — was creating an opening for bargain-hunting investors. After all, we’re talking about the fourth-largest economy in Europe (after Germany, France and the U.K.), an economy that has a fairly impressive industrial base. My initial thought was to steer clear as the open-ended economic crisis in the region could really hurt Italy in 2012, as the county enacts a set of belt-tightening moves. But if you are a regular reader of my articles, then you know I’m an assiduous bargain hunter.

So I decided to dig deeper.

Indeed, Italy’s economic woes merit investors’ attention. At least the iShares MSCI Italy Index Fund  (NYSE: EWI) does. The fund holds a basket of Italy’s top companies, many of which can be trusted to deliver steady results in any economic climate.

But because this fund is down from $20 to $12 this year, and down from $35 at the end of 2007 many may think its holdings are in deep trouble. This is not the case. For example, 22% of the fund is invested in Eni (NYSE: E), which is sort of the “ExxonMobil of Italy.” Eni’s performance is a lot more beholden to oil prices, which are quite firm, than any Italian economic trends. The oil giant generates about $145 billion in annual sales and typically earns about $5 per American depositary receipt (ADR).

In fact, Eni has little to do with Italy in terms of either revenue or expenses. This is a company with a strong presence in Europe, Asia, Oceania, Africa and the Americas, a true multinational. As Morningstar recently noted, “Eni stands out from many much-larger global integrated oil peers … because of strong diplomatic ties forged by management. This allows the company to operate more effectively in difficult markets such as North Africa, the Middle East and Russia, and is well illustrated by the fact that Eni is the largest international oil and gas producer in Africa.” Morningstar’s analysts say that shares, trading at a recent $41, are worth $65.

The EWI’s second-largest position is in ENEL, which comprises 12% of the fund. ENEL is one of Europe’s largest utilities, with operations in a number of countries. As with all other utilities, ENEL has a guaranteed rate of return on a cost-plus basis. Its operating margin has never wavered from the 15% to 18% range in the past eight years, and there’s no reason to expect this to change.

But here’s where things get a bit tricky. The third- and fourth-largest holdings are in a pair of banks — Intesa SanPaolo and UniCredit. Taken together, they comprise about 13% of the fund. How will these banks fare in the current crisis? Nobody knows, but it’s instructive that Italy’s new political leadership is focusing on austerity measures and not seeking to fix the debt problem by welching on loans. To be sure, these banks may post weak results for the next year or two as the Italian economy weakens further, but barring any change in policy that leads to loan write-offs, these banks could represent deep-value plays once the crisis has passed. Their shares have fallen 50% or more from their 52-week highs and now trade well below tangible book value.

Moving further down the list are holdings such as Telecom Italia (NYSE: TI), tire maker Pirelli, eyewear purveyor Luxottica (NYSE: LUX) and automaker Fiat (Pink Sheets: FIATY). A slowing European economy will likely dampen results in 2012 for these firms, which the plunging share price for this fund already appears to anticipate.

As we saw in the United States in late 2008 and early 2009, it’s darkest before the dawn, so turning aggressive when the news appears to be extremely bleak can make for a profitable trade for long-term investors. Italy has myriad problems, but remains as one of the most dynamic hosts of industrial firms in Europe and elsewhere. The fact that the euro is trading at multiyear lows against the dollar, the yen and the yuan should make Italy’s industrial base that much more competitive.

Risks to Consider: This is an intriguing set up, but it pays to watch events in the next week or two before making a move. The fund is unlikely to quickly surge in value, so you can exercise patience before making a move.

Action to Take –> Jumping into Italian stocks after a sharp sell-off looks to be a wise long-term play. But you can’t ignore the risk that economic conditions could spiral even lower before they improve. As a result, a paired trade would be ideal to protect yourself in terms of potential downside. A short position in the PowerShares DB 3x Italian Treasury Bond ETN (Nasdaq: ILTI) off-setting a long position in the Italy fund may be the best play. When a solution to the economic crisis finally comes into focus, the equity fund is likely to appreciate much more robustly than the short position in the bond fund is to depreciate.