Those who have been riding the mining and oil sectors surge must be feeling very pleased. Since the market bottomed in the middle of August, mining and oil stocks have outpaced the S&P/ASX 200 by 12% and 18%, respectively, and our commodity price review has boosted the share price targets of stocks in these sectors.

Fuelling the rally in mining stocks are higher base and precious metals prices and optimism about the upcoming iron ore contract negotiations. Most base metals have recovered strongly in the past two months due to the weakening US dollar and easing concerns about the health of the US economy. Meanwhile, gold is hovering near 28-year highs due to strong investment inflows, which prompted us to increase our long-term gold price by 10%.

Also aiding sentiment are signs that China's voracious appetite for industrial metals is increasing at a time when labour unrest, production hiccups and geopolitical tension are constraining the supply of some base metals, most notably, copper and lead.

Although copper is regarded as a price leader among base metals, lead has stolen much of the limelight, as speculation of a 90K-100K tonne supply shortfall this year pushed lead up 32% in two months to fresh record highs. Supply tightness should ease a little in CY08, but supply is still expected to be constrained. For this reason, our price forecast for lead enjoys the biggest upgrade of all metals for the next two years. Other base metals to enjoy a significant upward lift include tin and copper.

However, the "flavour" of the month is iron ore, as contract negotiations between steel mills and iron ore producers loom. Growing speculation that BHP might finally get its wish to charge a transport "premium" would mean a much bigger than expected jump in iron ore contract prices. Currently, Chinese mills pay more for Brazilian ore than Australian ore due to higher transport costs. BHP tried to correct this imbalance previously and drew an angry response from the Chinese. Even if BHP got half of the transport differential, it would lift iron ore prices by about 50%, and every US$1 per tonne extra BHP gets for iron ore adds US$43M to its NPAT. RIO stands to gain more, as it produces more iron ore than BHP.

We have lifted our iron ore forecast by a conservative 15%, leaving room for an upgrade later in the year. We have also lifted coking coal prices on anticipated strong demand from steel producers.

In the energy sector, crude oil hit a record high in late September to above US$83/barrel and has been stubbornly clinging to most of its gains. We believe demand growth will continue to outpace new oil discoveries, and we have increased our oil forecast for the next four years. This has resulted in a modest boost to price targets for most oil stocks.

The stocks that benefited the most from our commodity price review include Newcrest Mining (NCM), Oxiana (OXR), BHP and Santos (STO). However, the sharp rally in the mining and energy sectors means there are few value buys left to be found.

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