* Investors bet on low inventory, production
* Steel mills likely to resume output after holiday
* Iron ore buying seen to pick up
* Iron ore futures hit a three-week high (Updates close prices)
SHANGHAI, Jan 27 (Reuters) - Chinese steel futures surged to a four-month high on Wednesday as investors expect demand in the world's top producer to pick up amid low inventories after the coming Lunar New Year holiday, boosting raw material iron ore prices higher as well.
The most-traded rebar futures contract for May on the Shanghai Futures Exchange SRBcv1 rose to a session high of 1,871 yuan ($284.40) a tonne, its highest since Sept. 28. It closed up 1.3 percent at 1,863 yuan a tonne.
Steel mills are running at low operational rates due to stagnant sales and shortages of cash, but end-users are expected to restock low inventories after the approaching holiday, which will encourage mills to resume production.
China's Lunar New Year holiday falls in early February this year, with the country's financial markets to be closed for a the week starting Feb. 8.
"The spike is mainly driven by low production and inventories, which are at historical low levels. Meanwhile, demand is also expected to improve after the holiday," said Chen Guanyin, an analyst with Minmetals & Jingyi Futures in Shenzhen.
"However, restocking may not be aggressive due to tight cash flow," Chen said.
Steel mills are expected to step up production and buy iron ore after the holiday, giving a lift to the raw material that has been dented by expectations that China's demand will slow this year while global supplies keep rising.
Though the overall supply of iron ore keeps pressuring prices, seasonal rains could disrupt first-quarter shipments and also help to support prices, Chen said.
The most active iron ore futures for May settlement on the Dalian Commodity Exchange DCIOcv1 surged nearly 4 percent to a three-week high of 326 yuan a tonne in early trade. The contract rose 3.2 percent to close at 324.5 yuan a tonne.
Iron ore for immediate delivery to China's Tianjin port .IO62-CNI=SI extended losses on Tuesday, dropping 0.7 percent to $40.80 a tonne, according to The Steel Index. Rebar and iron ore prices at 0712 GMT
Contract
Last
Change Pct Change
SHFE REBAR MAY6
1863
+23.00
+1.25
DALIAN IRON ORE DCE DCIO MAY6
324.5
+10.00
+3.18
SGX IRON ORE FUTURES FEB
41.03
+0.61
+1.51
THE STEEL INDEX 62 PCT INDEX
40.8
-0.30
-0.73
METAL BULLETIN INDEX
41.08
-0.49
-1.18
Dalian iron ore and Shanghai rebar in yuan/tonne
Index in dollars/tonne, show close for the previous trading day
($1 = 6.5789 Chinese yuan)