In a post at the SEGA Forums, SEGA Brand Manager Ken Balough has cleared up the confusion regarding where Sonic CD happens in the Sonic timeline and it turns out that SEGA is NOT placing the game between Sonic 3 & Knuckles and Sonic the Hedgehog 4: Episode 1, or anywhere else either. Balough explains that while they’re not moving Sonic CD, the game’s events are very important to Sonic the Hedgehog 4, and that’s why they’re giving fans the chance to play it for the first time with this new port.

Hi Everyone!!

Ok so I’m at PAx right now showing off Sonic CD to every lucky person who’s attending the show (by the way if you are here – it’s at the MSFT booth.)

But I have a few minutes and I’ve seen some confusion about Sonic CD being a prequel – and it is!! Just as you imagined it.
which is basically my way of saying – allow me to illuminate the situation.

Remember back during Ep 1, I was saying we had outlined a great story for the Sonic 4 Saga? It all come back to that Cliffhanger at the end – where we brought back Metal Sonic. Sonic CD was never really tied to the numberical Sonics in any significant way back in the 90′s. Sonic 4 is going to change that, and bridge these adventures together in a meaningful way.
While we are not taking away “when CD happened” in relationship to the numerical versions, we can tell you that the events in CD are very important to 4 (as you can imagine from us bringing Metal Sonic back)

So before we take you to Ep 2, we’re gonna give all you fans a chance to experiance CD for the first time in years – and with a terrific presentation in wide screen. And yes the physics are fine!

So as you can see from the Trailer we created – Sonic took a slight detour into “The Past”, and later will be propelled back into the future to resume the Sonic 4 Saga

And if your at PAX come say Hi!

Cheers,
Ken

Source: SEGA Forum (via Sonic Retro)