* Irish, Portuguese, Italian bond yields rise
* Spanish bonds outperform, but yields off 8-yr low
* Investors are already long in Spain, Italy - Citi
By Marius Zaharia
LONDON, Jan 23 (Reuters) - Lower-rated euro zone bonds surrendered historically low yield levels on Thursday as investors sold on some of the peripheral paper they have been flooded with since the start of the year.
In the latest sale of bonds from the euro zone's more vulnerable economies, Spain issued 10 billion euros ($13.6 billion) of a new 10-year bond on Wednesday, drawing demand of almost 40 billion - a record for European governments.
Helped by an improving euro zone growth outlook, Madrid has sold larger-than-expected amounts of bonds every week since the start of the year, completing 16.6 percent of this year's 133.3 billion euros funding target already.
This follows strong sales in Ireland, Portugal and Italy, with Rome due to sell bonds next week as well.
Traders said the large amounts of supply hitting the market have left some investors holding more paper from these peripheral economies than they want or are allowed to keep by their risk managers.
Irish 10-year yields rose 3 basis points to 3.32 percent, while equivalent Italian yields rose 2 bps to 3.85 percent and Portuguese yields jumped 6 bps to 4.976 percent. Spanish yields were flat at 3.74 percent, having pushed away from recent eight-year lows late on Wednesday after the sale.
Irish yields hit record lows this week, Portuguese yields hit their lowest since mid-2010, while Italian yields also hit multi-month lows recently. While signs of recovery in these economies have reassured investors that government finances will improve, yields rose on Thursday despite forecast-beating euro zone business surveys.
"One reason is related to supply," UniCredit rate strategist Luca Cazzulani said. "The other reason is psychological ... If you look at history it is not uncommon at the end of January to have a reversal."
German 10-year Bund yields, the euro zone benchmark, edged down to 1.73 percent.
The large amounts of bonds hitting the market may prompt a pause in this year's strong rally in lower-rated bonds, especially given that the amount of debt to be sold exceeds scheduled repayments in February.
"People are fairly long of this stuff (peripheral bonds) so there might be some supply indigestion," one trader said.
A "long" position is in effect a bet on further price rises. A "short" is a bet in the opposite direction.
Using global flows data, analysts at Citi have come up with a seven-notch scale of how investors are positioned in certain markets, ranging from "very short" to "very long".
They said hedge funds globally and U.S. "real money" investors were "very long" Spanish bonds, while domestic investors and those based in the euro zone and the UK were "long". Central banks were "small long", while Japanese investors were "small short".
"Real money" is market jargon for long-term investors, usually pension funds and insurers.
In the Italian bond market, hedge funds and real money investors in the euro zone and the UK were "long", while U.S. real money investors were "short". In general investors in Ireland were less long than in Spain and Italy, Citi said.
"In both Italy and Spain there is a clear preponderance of longs, with the positions being more pronounced in Spain," Citi analysts said in a note. "We are not concerned about this imbalance at this stage, given the underlying dynamics (appetite for yield), but watch position changes closely."