China, HK shares mark rocky end to grim August

* China shares record 21 pct drop in August

* Shanghai index drops below watershed 125-day moving average

* HK shares mark first monthly drop in six months

* A-H share premium gap at lowest since Jan 2009

* Chine Merchants Bank shares drop on new fund-raising target
(Updates to close)

By Parvathy Ullatil & Claire Zhang

HONG KONG/SHANGHAI, Aug 31 (Reuters) - China shares dived 6.7
percent on Monday to a three-month closing low and recorded its
second-biggest monthly loss in 15 years, after surging stock
valuations overwhelmed improvements in corporate earnings while
new share supplies compounded a drop in liquidity.

Hong Kong stocks followed suit, giving up 1.9 percent,
marking its first monthly loss in six months.

Reflecting a clear weakening in investor sentiment, Chinese
fund managers reduced their recommended allocation to equities
for the first time in six months, on concerns that a possible
liquidity tightening may sap demand for stocks, the latest
monthly Reuters poll of fund managers shows.

The Shanghai main index slipped below the 125-day moving
average for the first time since early February. The drop below
the key chart line, used by many Chinese investors to delineate a
bull versus a bear market, encouraged more investors to flee
stocks.

"Shorts and longs may still fight for control of that
(125-day moving average) level in coming days, but the market
will in any event remain sluggish in the first half of September
as investors await August economic data," said analyst Qian
Xiangjing at CITIC-Kington Securities in Hangzhou.

CM BANK SKIDS AFTER EARNINGS

China Merchants Bank (3968.HK) skidded 3.2 percent to
HK$16.88 after the country's sixth-largest lender raised its
maximum fund-raising target for a planned rights issue by 22
percent to 18 billion-22 billion yuan ($2.6-3.2 billion), due to
a likely tightening of banks' capital adequacy rules.

Its Shanghai stock (600036.SS) closed down 6.26 percent at
13.63 yuan.

The stock was the worst performer among Chinese banks on
Monday after the lender announced a 37.6 percent slide in its
first-half profit on account of a sharp contraction in its net
interest margins and a rise in its credit cost during the period.

The benchmark Hang Seng Index .HSI finished 374.43 points
lower at 19,724.19, a five-week closing low for the index.

The gauge dropped 4.1 percent in August, paring its yearly
gain to 37 percent while the premium gap .HSCAHPI between
yuan-denominated A-shares and their Hong Kong-listed counterparts
dropped to 16 percent, its lowest since January this year.

Analysts predict a volatile September for the markets with
the main index loosely supported at 19,462 points, its 50-day
moving average.

"There is still the hope that the Chinese market will
stabilise before Oct. 1, the mainland's 60th anniversary. But if
the Hang Seng doesn't claw its way back above 20,000 points in
the next day or two then there is less chance of stability in the
rest of the month," said Linus Yip, strategist with First
Shanghai Securities.

The China Enterprises Index .HSCE, which represents top
locally listed mainland Chinese stocks, was down 1.4 percent at
11,278.26 while the Shanghai Composite Index .SSEC had tumbled
6.7 percent.

China Southern Airlines (1055.HK) tanked 4.3 percent to
HK$2.43 after it said its net profit fell 97 percent in the first
half of 2009, reflecting the impact of the outbreak of Influenza
A H1N1 and intensified market competition, in addition to the
global economic slowdown.

BYD Co (1211.HK) bucked the downtrend to vault 8 percent
after its chairman said MidAmerican Energy Holdings, a unit of
U.S. billionaire Warren Buffett's Berkshire Hathaway (BRKa.N),
intends to raise it stake in the company from the around 10
percent it holds now.

BIGGEST MONTHLY DROP SINCE OCT 08

The Shanghai Composite Index .SSEC closed at 2,667.745
points, posting its biggest daily drop in 15 months. It tumbled
21.8 percent in August after recording seven consecutive monthly
gains.

A boom in initial public offerings was also cited by some
fund managers as a risk to the stock market, which rallied 60
percent in the first six months of this year on ample liquidity
and an improving economy. [ID:nSHA365895]

Analysts saw no significant fresh factors emerging on Monday.

"Weak sentiment dominated the market today, with few
investors daring to brave the force of the selling," said senior
analyst Chen Shaodan at Stockfly Securities in Beijing.

Continuing a stream of fresh shares flowing into the market,
Metallurgical Corp of China's Shanghai A-share initial public
offering, which aims to raise about 16.85 billion yuan ($2.47
billion), will start book-building on Tuesday and take
subscriptions next week. [ID:nSHA362276].

A convincing breach of the key moving average, which analysts
said still requires a few days to confirm, would put the index's
next support at 2,500, a more psychological level than technical
one. That would suggest a market more driven by investor
sentiment than by fundamentals.

Losing Shanghai A shares outnumbered gainers by 859 to 27
while turnover for Shanghai A shares dropped to thin 124 billion
yuan ($18 billion) from Friday's 133 billion yuan, reflecting a
lack of buyers, traders said.

The index sank 2.9 percent on Friday amid worries about a
steep drop in Chinese bank lending in August, which would trim
liquidity flowing into stocks.

But analysts said slowing lending should have no major impact
on the economy, partly because Chinese companies are turning a
large share of the short-term discounted bill financing they
received in the first half of this year into long-term investment
in the second half.

"We believe that the plunge since early August, after the 103
percent gain since late 2008, was likely triggered by excessive
fears of aggressive policy tightening, while the fundamentals
remain intact," JPMorgan's Hong Kong-based economist Qian Wang
said in a research report late last week.

"The implications for the real economy are likely to be
modest; we hold to our view that Chinese real GDP will expand a
solid 8.4 percent on year in 2009."

(Editing by Edmund Klamann and Jacqueline Wong)