* Turnover in HK shares drops to HK$50.7 billion ($6.5 bln)
* Xinjiang stocks mixed for second day amid unrest
* Cathay Pacific bucks trend to soar on broker upgrade (Updates to close)
By Parvathy Ullatil and Claire Zhang
HONG KONG, July 7 (Reuters) - Hong Kong shares dropped 0.7 percent as the lack of conviction in a global economic recovery pushed investors to lock in some of the gains made in a four-month rally and kept turnover thin.
Shanghai stocks succumbed to profit-taking after a four-session rally, posting their the biggest daily percentage drop in more than three weeks.
A dry spell for positive news on the global economy has forced fund managers into wait-and-see mode in following a winning stretch by the market.
"Investors are still hesitant to give up on the market and miss their chance to capture this rebound, but with overseas markets losing momentum there is a total lack of direction," said Ben Kwong, chief operating officer with KGI Asia.
CAUTIOUN SEEN IN JULY, AUGUST
The benchmark Hang Seng Index fell 0.7 percent or 117.14 points to 17,862.27, shedding early gains as Chinese stocks extended losses.
Turnover languished at HK$50.7 billion compared with Monday's HK$54.2 billion.
The main index has been hovering between 17,800 and 18,200 points since late last week, but investors anticipate a bigger correction in the event of news that challenges the assumption of a gradual recovery in the global economy.
Analysts see the next major support for the index at around 16,000 points, close to its 38.2 percent Fibonacci retracement from the bottom it scraped in March to its June highs and the double peak high it hit in April.
"Investors may stay cautious in July-August as we head into the earnings season and the time to verify if there is a V-shaped recovery in the US. China equities will also correct, but should outperform globally," said analysts with RBS, forecasting a 10 to 15 percent retreat by the China Enterprises Index.
China Unicom, the country's second-largest wireless service provider, rose 2.4 percent on speculation it was close to signing a deal to launch Apple's popular iPhone handset in China.
The China Enterprises Index, which represents top locally listed mainland Chinese stocks, fell 1.4 percent or 152.95 points to 10,674.67.
Cathay Pacific jumped 6.2 percent to HK$10.90 after JP Morgan raised its rating on the stock to "overweight" from "underweight" on expectations that the airline's earnings outlook will become more positive.
The brokerage increased its target price to HK$13 from HK$7, saying Asia's third-largest airline would outperform peers with a marginal profit in 2009, helped by better average loads, cost-cutting measures including capacity rationalization, and mark-to-market fuel hedging gains.
China Mengniu Dairy gained after it said it would raise HK$3.058 billion ($394.6 million) from a share sale to China National Oils, Foodstuffs and Cereals Corp (COFCO) and Hopu Investment Management. Shares in the company, which saw sales drop sharply following last year's tainted milk scandal, were up 1.2 percent, trimming strong gains as concern over equity dilution following the new share issue weighed.
Huadian Power jumped 3.5 percent to HK$2.65 in Hong Kong and 10 percent to 5.83 yuan in Shanghai after it said it would acquire 70 percent stakes in two in Shanxi-based coal miners for about 760 million yuan ($111.2 million) to ensure coal supply to the company's power plants.
LENDING RISKS IN FOCUS IN SHANGHAI
Chinese stocks slipped 1.13 percent on Tuesday, snapping a four-day rally, on profit-taking with property and bank shares dropping after a regulator warned of lending risks while coal and oil refinery shares were hit by lower oil prices.
The Shanghai Composite Index ended down 35.217 points at 3,089.450 after hitting a new 13-month intraday high of 3,130.067.
Gaining Shanghai A shares outnumbered losers by 485 to 437, while turnover in Shanghai A shares dropped to 187.6 billion yuan ($27.5 billion) from Monday's 21-month high of 203.3 billion yuan.
China's massive infrastructure lending is posing increasing risks for the banking system, a senior regulator said in comments published on Tuesday.
Total bank lending is likely to top 10 trillion yuan in 2009, doubling the government's initial target of at least 5 trillion yuan.
"Profit-taking pressure is increasing and weak oil prices are weighing on certain sectors. The index is likely to ease after its recent quick gains," said Western Securities analyst Cao Xuefeng.
Property sector leader, Vanke sank 2 percent to 14.09 yuan, while the country's biggest lender, Industrial & Commercial Bank of China sagged 2.2 percent to 5.43 yuan.
Coal shares were hit after recent lower oil prices. China Shenhua Energy lost 2 percent to 32.83 yuan, while the most heavily-weighted stock on the index, PetroChina, dropped 2.2 percent to 14.82 yuan.
Steel shares were strong for a second day, with Liuzhou Steel up 8.8 percent at 7.70 yuan after saying its operations were unaffected by heavy flooding in the region. The worst floods to hit Guangxi since 1996 have affected 10 percent of sugarcane-growing areas in Liuzhou, a local official said on Tuesday.
Xinjiang-linked stocks were mixed for the second day, with Xinjiang Tianshan Wool Tex, based in Urumqi, rising 0.4 percent to 5.10 yuan after sinking 4 percent on Monday.
Hundreds of Uighur protesters clashed with Chinese anti-riot police in the capital of China's Muslim region of Xinjiang on Tuesday, two days after ethnic unrest left 156 dead and more than 800 injured.
"Urumqi has a limited number of listed companies, so the impact will also be very limited," Cao added. For the latest technical analysis on the HSI and SSEC click on http://www.reutersindia.net/ (Editing by Ben Blanchard and Chris Lewis)