* Spot iron ore at 3-week highs as traders take positions
* Baosteel keeps main product prices steady for Aug
By Manolo Serapio Jr
SINGAPORE, July 12 (Reuters) - Shanghai steel futures edged up to one-month highs on Tuesday as investors bet that Chinese steel output would remain strong despite the country's efforts to tighten liquidity.
Spot iron ore prices piggybacked on gains in steel, hitting their highest in three weeks, as traders took positions on expectations that Chinese steel mills would continue to restock on the steelmaking ingredient.
The most-active October rebar contract on the Shanghai Futures Exchange rose for a second straight session, hitting a high of 4,873 yuan a tonne, its loftiest since June 9. It stood at 4,863 yuan by the midday break, up 0.2 percent.
China's average daily crude steel output rose to a record above 2 million tonnes towards the end of June as mills kept pace with a resilient construction sector buoyed by the government's race to build more low-cost housing units.
"The record steel production through June has boosted sentiment in the market," said an iron ore trader in Shanghai. "Given all the worries about a cooling Chinese economy, steel production hasn't gone down, so there must be demand out there."
The improved sentiment spilled into the iron ore market, with spot prices extending gains from last week, after dropping around 2 percent in June.
Iron ore with 62 percent iron content rose 0.1 percent to $171.71 a tonne on Monday, according to price provider Metal Bulletin .IO62-CNO=MB. A similar gauge by the Steel Index .IO62-CNI=SI edged up to $171.30 from $171.20.
Both indexes, based on China spot transactions, are at their highest levels since late June.
Spot offers were steady, with Australian 62-grade Newman fines at $176-$178 a tonne, including freight, Chinese consultancy Umetal said.
Ore with 63.6/63 iron content from India was quoted at $179-$181 a tonne.
"I think the main driver in iron ore is the big traders trying to take positions. They are buying some big cargoes," said a shipping manager for an iron ore trading firm in Shanghai.
"But I haven't seen a strong comeback from the steel mills yet and it's because cash remains tight," he said.
Tighter liquidity, thanks to China's repeated increases in interest rates and bank reserve ratios, has made it difficult for Chinese steelmakers to fund operations, including the purchase of raw materials like iron ore.
This has prompted many small and medium-sized steel mills in China to either buy iron ore from domestic suppliers or from stocks of imported ore already lying in Chinese ports which are cheaper than spot cargoes.
"I had thought iron ore prices would crash by $10-$15, but looking at what's happening with Chinese steel output, this stability in prices will probably continue for some time," said the Shanghai trader.
"July and August are months to watch out for in terms of Chinese steel production. If there will be a fall, it should happen during these months. September onwards I would put money on stability and prices going up."
Baoshan Iron & Steel , China's biggest-listed steelmaker, on Monday said it would keep prices of its main products mostly unchanged for August bookings. Analysts say high production costs are also keeping steel mills from cutting prices.
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