UPDATE 1-Iron ore falls with steel in China, but outlook firm

* Healthy steel margins to keep iron ore between $80-$90 - Goldman

* China’s iron ore ports stocks at 131 mln T, highest since 2004 (Updates prices)

MANILA, March 21 (Reuters) - Steel and iron ore futures in China dropped about 4 percent on Tuesday, retreating after recent sharp gains though the outlook for both commodities remains firm with steel demand likely to sustain healthy margins among mills over the next month.

Both commodity futures marked their biggest weekly rallies in two months last week.

The most-active rebar on the Shanghai Futures Exchange closed down 4.4 percent at 3,229 yuan ($468) a tonne.

Iron ore on the Dalian Commodity Exchange slid 4 percent to 687.50 yuan per tonne.

Steel consumption in China, the world’s top user, increased about 8 percent in January and February from a year ago, suggesting that steel inventory remains low, Goldman Sachs said in a report.

“Given that March and April are the peak demand season, we expect inventory levels to remain low until late April and price volatility to stay elevated in coming weeks,” it said.

Rebar inventory among Chinese traders stood at 7.2 million tonnes as of March 17, the lowest since early February, according to data from SteelHome consultancy. SH-TOT-RBARINV

Steel margins among Chinese mills are near record highs and they should last through peak demand season, Goldman said.

“Given this expectation of steel margins, we expect iron ore prices to stay in the $80-90/tonne range until the end of April. However, we still expect a downturn in late second quarter or second half of 2017 when seasonal demand weakness and supply strength start to play out,” the bank said.

Iron ore for delivery to China's Qingdao port .IO62-CNO=MB slipped 0.9 percent to $91.49 a tonne on Monday, dropping for a second session in a row, according to Metal Bulletin.

Stocks of iron ore at China's major ports reached 131 million tonnes on Friday, the highest since 2004 when SteelHome began tracking this data. SH-TOT-IRONINV

Surplus conditions in China are less severe than the port stocks suggest, with inventory closer to the historical six-year average, Commonwealth Bank of Australia said in a note.

“The data also masks the quality of ore held at Chinese ports. Anecdotal data suggests that most of the stockpiles are of low quality and that mills continue to bid up higher quality iron ore in an attempt to maximise margins.” ($1 = 6.8987 Chinese yuan) (Reporting by Manolo Serapio Jr.; Editing by Sunil Nair)