Fortescue Metals Group Ltd and China Investment Corp (CIC), China's $200 billion sovereign wealth fund, are in advanced talks on a $1 billion-plus convertible bond investment to help the Australian iron ore miner fund its expansion, two sources said on Tuesday.

The talks follow news on Monday that China's Yanzhou Coal agreed to buy Australian coal miner Felix Resources in a deal worth up to $3.3 billion.

China is increasingly looking to less politically sensitive joint ventures and financing deals, rather than takeovers, to invest in global natural resources to support its economic growth.

Fortescue needs fairly significant funds to expand, said James Wilson, an analyst at DJ Carmichael, noting Australia's third-largest iron ore miner after Rio Tinto and BHP Billiton aims to treble its annual production over the long term from 30-40 million tonnes now.

They have what, about $500 million in profits? That's not going to cut it if they want to expand, he said.

The potential financing deal comes at a sensitive time for Australia-China relations, following China's detention a month ago of four Rio Tinto employees in Shanghai on suspicion of stealing state secrets.

The men, including Australian Stern Hu, remain in detention and have yet to be charged, increasing political pressure on Australia's Mandarin-speaking Prime Minister Kevin Rudd.

Earlier in the year, Rio walked away from a $19.5 billion deal with China's state-owned Chinalco in favor of a tie up with rival BHP Billiton.

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Still, analysts and bankers expect Chinese companies to pursue other Australian resource firms. So far this year, Chinese firms have invested about $2.2 billion in Australian energy and resource companies.

CIC's top officials paid a low-profile visit to Australia in July and had closed door meetings with Fortescue to discuss the potential funding, one of the sources said.

Investment is investment, said the source with knowledge of CIC's overseas strategy. Australia is still very important to China in terms of the bilateral trade relationship.

Plus, a convertible bond is safe as an investment tool in this case, the source added.

Spokesmen for CIC and Fortescue declined to comment. Shares in Fortescue ended 1.2 percent higher on Tuesday.

In recent months, China's sovereign wealth fund has shifted its strategy toward investments in natural resources. Last month, CIC bought a 17.2 percent equity stake in Canada's Teck Resources.

That deal did not require government approval under Canada's foreign investment rules, which only review transactions when a foreign company takes control of a domestic firm.

Fortescue is also talking to different parties about other funding options, an investment banker with direct knowledge of Fortescue's strategy told Reuters.

Both sources declined to be named because they were unauthorized to speak publicly about the matter.

Earlier this year, China's Valin Iron & Steel Co was cleared by foreign investment regulators in Australia to take up a 17.55 percent direct interest in Fortescue for around $770 million.

CIC was created in 2007 to manage part of China's roughly $2 trillion foreign exchange reserves for higher returns.

The fund became wary of overseas expansion after losing money from its investments in Morgan Stanley and Blackstone, but is now pursuing new deals abroad as the global financial crisis eases.

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