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By Nicole Mordant and John Tilak

VANCOUVER/TORONTO, March 20 (Reuters) - Dominion Diamond Corp and fellow Canadian diamond miner Stornoway Diamond Corp have held talks about a potential merger in recent months, people familiar with the matter said on Monday.

World No. 3 diamond miner Dominion, target of a $1.1 billion bid by U.S. billionaire Dennis Washington, and Stornoway, a small miner with a diamond mine in Quebec, declined to comment. The people declined to be named as the discussions are private.

One of the people said the talks were still ongoing.

The talks include Stornoway's chief executive officer and president, Matt Manson, becoming CEO of the merged group, one source said, adding that the discussions on an all-share merger started in January.

Dominion, which owns the Ekati diamond mine in Canada's Northwest Territories and a 40 percent stake in the nearby Diavik mine, is looking fo r a new CEO after announcing on Jan. 30 that Brendan Bell had resigned.

A union with Dominion would give Stornoway, which owns a single mine, an avenue for growth, the sources said.

On Sunday, The Washington Companies, a group of privately held North American mining, industrial and transportation businesses founded by Dennis Washington, announced that it had made a $1.1 billion all-cash proposal for Dominion.

Dominion said in a statement late Sunday that its board had considered Washington's unsolicited proposal, but the terms of the proposed talks were unusual and unacceptable.

The Washington offer comes at a time when some analysts are talking of diamond supply peaking as big new deposits become harder to find and mines, often in remote regions, take longer and are more expensive to build.

Shares in Dominion surged as much as 26 percent on Monday on the Washington proposal to a session high of $12.53 on the New York Stock Exchange. They closed at $12 .20 for a gain of 23 percent, below the $13.50 a share Washington offered.

Lawrence Simkins, president of Missoula, Montana-based Washington, said in Sunday's statement the group remained "fully committed to completing this transaction."

The group declined to comment on Monday when asked if it would take its offer directly to Dominion shareholders.

Washington's proposal puts Dominion into play and brings the "long-awaited kickoff of Canadian diamond consolidation," brokerage Canaccord Genuity said in a note to clients.

In addition to Washington, there are several other "logical" potential suitors for Dominion, including global mining giant Rio Tinto and Anglo American-owned diamond giant De Beers, Canaccord said.

Rio is already a partner of Dominion, owning 60 percent of the Diavik mine. De Beers has diamond mines and exploration interests in Canada.

Both Rio and Anglo declined to comment.

"There is certainly the potential for lots of peopl e to take a look at (Dominion). Whether that translates into meaningful action I would be somewhat more cautious on," BMO analyst Edward Sterck said.

Large global miners are still slashing heavy debt loads as they emerge from a deep commodities downturn, he said. (Reporting by Nicole Mordant in Vancouver and John Tilak in Toronto; Additional reporting by Barbara Lewis in London and Susan Taylor in Toronto; Editing by Denny Thomas and Leslie Adler)