* Nikkei drops over 1 pct to 3-week low * Investors shed positions after North Korea news * Small cap defense-related shares soar By Mari Saito TOKYO, Dec 19 (Reuters) - Japan's Nikkei share average fell to a three-week low on Monday, hurt by news that North Korean leader Kim Jong-il had died and as worries over Europe's debt crisis increased after Fitch Ratings warned of possible downgrades for seven European nations. The benchmark Nikkei closed down 1.3 percent at 8,296.12, after earlier falling as low as 8,272. The broader Topix index lost 1 percent to 716.38. North Korea's leader Kim died of a heart attack while on a train trip, state media reported, sparking immediate concern over the political stability of the reclusive state and its nuclear programme. "South Korea's reaction to this will be in focus. The risk or fear that the death of Kim Jong-il will lead to provocation by North Korea is prompting selling," said Hiroyuki Fukunaga, CEO of Investrust. Investors shed positions as they awaited further news out of North Korea, while strategists said the fall was limited for now. "Investors are taking a wait-and-see approach to see if the situation in North Korea will take a turn for the worse, and market participants are not able to grasp the whole situation yet. For now, people are getting rid of their positions," said Masayuki Otani, chief market analyst at Securities Japan. Tokyo stocks extended losses on the North Korean news after worries about Europe had pushed the Nikkei lower in the morning, wiping out any improvement in sentiment that had been made on the back of encouraging U.S. economic data last week. Fitch Ratings warned on Friday it may downgrade France and six other euro zone countries, saying a comprehensive solution to the region's debt crisis was "technically and politically beyond reach." The Nikkei remained below its 25-day moving average near 8,476 on Monday, now seen as a key resistance point. Market participants expected support to come from the Bank of Japan's buying of exchange-traded funds and from bargain-hunting by pension funds. DEFENSE-RELATED SHARES SOAR Small-cap defense-related shares soared after the North Korea news, with Ishikawa Seisaku, a contractor for the Defence Ministry, rising 17.2 percent to 68 yen and Howa Machinery, which makes firearms, gaining 7.9 percent to 68 yen. Nippon Avionics, a manufacturer of defense electronics equipment, jumped 12.2 percent to 120 yen. Market players also said investors were seen buying Nikkei put options at 8,250. Shippers and securities firms were the biggest percentage losers on the main board, with Tokyo's sea transport subindex falling 4.8 percent and the securities subindex dropping 3.7 percent. Olympus Corp, at the centre of a $1.7 billion accounting fraud, dropped 8.9 percent to 915 yen in its fourth day of losses. U.S. fund manager Southeastern Asset Management, which holds 5 percent of the firm, said it was worried the current Olympus board may be gearing up to dilute existing shareholders in a bid to stay in power. Nissan Motor Co bucked the market and rose 2.1 percent to 682 yen, becoming the heaviest-traded share by turnover on the main board, after the automaker said it would buy up to 0.3 percent of its shares outstanding for as much as 10 billion yen between Monday and Thursday. Volume remained thin, with 1.44 billion shares changing hands on the main board, down from 1.48 billion shares on Friday. Declining stocks outpaced advancing issues 1,109 to 449.