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WRAPUP 1-China steel prices succumb to biggest drop since Oct

 * China spot prices down 8 pct, futures continue their
slide
 * Shanghai rebar futures open interest doubles in Aug
 * Strong output growth raises oversupply concerns
 SEOUL, Aug 20 (Reuters) - As debate grows over the possible
deflation, or not, of a China asset price bubble, the commodity
right at the core of the world's third-largest economy has this
week succumbed to its sharpest correction this year -- steel.
 After a months-long rally to a 10-month high last week, the
price of benchmark hot-rolled coil in China -- which makes half
the world's steel -- plunged 7.6 percent to around 3,987.5 yuan
a tonne this week, data from Metal Bulletin showed.
 That in turn has dragged iron ore prices off their peaks as
well, with Indian spot market exporters reporting virtually no
deals this week, adding further complexity to price
negotiations.
 The question, of course, is why: Has the outlook for
Chinese demand changed that dramatically? Has the risk of
tighter policy from Beijing spooked speculators? Or was this
simply a long overdue correction after a nearly 30 percent
rally since late April that most analysts had said ran far
ahead of fundamentals?
 The answer may be a bit of everything.
 Fundamentals, to be sure, are tenuous: amid the promise of
a steadily improving demand outlook driven by China's nearly
$600-billion infrastructure-focused stimulus plan, China's
steel mills pushed production to record 50.68 million tonnes in
July.
 At 600 million tonnes on an annualised basis -- a 20
percent surge from last year's 500 million tonnes -- output
appeared out of step with end-user demand which lagged far
behind.
 That heavy production had also pumped up demand for iron
ore, the main ingredient, but that too now appears to have
evaporated.
 "The market is not good. Liquidity in China is bad. I have
heard of iron ore deals being done at $105 a tonne" versus
$110-$112 last week, said an iron ore trader in New Delhi.
 "China is very speculative in nature. When they start
buying, they keep on buying and suddenly they stop ... We could
see it coming. We could see that the Chinese are not very
aggressive."
 FINANCIAL PLAY
 But steel, like other industrial metals, has over the past
month become an increasingly popular speculative play, with
China's easy credit policy driving funds toward any liquid
markets with a bright outlook.
 Shanghai rebar futures SRBc3 languished with minimal
trade after its March debut, but broke onto the main stage this
month, with trading volume surging seven-fold from end-July and
open interest nearly doubling in just over two weeks.
Meanwhile, prices have collapsed 14 percent from their record
high on Aug 4.
 "Everybody was buying a lot in July and now people are
realising that demand is getting better but steel prices are
already far ahead of the fundamental demand recovery," said
Julian Zhu, a Deutsche Bank analyst.
 "So prices are falling and open interest is rising because
people now have a lot of short positions."
 The liquidity-driven futures market is increasingly
dragging the more fundamental physical market with it -- as
Shanghai surged, mills rushed to raise prices even during the
dull summer season.
 The sell-off has coincided with China's stock market's
collapse of 20 percent in just two weeks, sparking worries that
it may signal underlying economic weakness in China, and
evidence of sharply reduced new bank lending in China could
extend it.
 "The liquidity-driven element of Chinese steel prices
appears to have been reversed over the past week and we expect
steel prices to continue to moderate in the face of very high
rates of production," Macquarie analysts said in a note this
week.
 New loans in July sharply shrank to 355.9 billion yuan from
1.53 trillion in June, as banks reined in credit after a record
surge in the first half, the central bank said. [ID:nBJB000646]
 The threat of destocking by speculative investors or
traders, uncertainty over end-user demand and continued
full-steam production by mills all loom large over the market.
 Even positive macro data -- such as the annual 11.6 percent
rise in housing investment in the first seven months -- failed
to counter widespread expectations of a pull-back that has just
begun.
 "Traders, who have restocked, feel that they do not need to
make fresh purchases at current levels, especially as they
expect prices to fall. This could lead to a further price
correction," Goldman Sachs analyst Rajeev Das said.
 "We still remain hopeful that 2010 demand will be strong
and will cause a more sustainable recovery in steel prices
then. In the interim, however, the end of restocking may cause
prices to soften...hence, the cycle's recovery may be
W-shaped."
 (Additional reporting by Ruchira Singh in MUMBAI, Alfred Cang
in SHANGHAI; Editing by Jonathan Leff)



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