* Short-covering buoys, retail investors cautious - analyst
* Weaker yen versus dollar, strong U.S. data support Nikkei
* Break above 9,800 would open way towards 10,000 - analysts
* But profit-taking interest strong below 9,800
By Aiko Hayashi and Chikafumi Hodo
TOKYO, Nov 8 (Reuters) - Japan's Nikkei average rose 1.1 percent to a three-month closing high on Monday, adding to gains made last week as risk money shifts towards global equities on improving prospects for the U.S. economy.
The outlook for the U.S. economy has brightened after the Federal Reserve decided to buy more debt and after encouraging U.S. jobs data, helping push the Nikkei, an index which has lagged other stock markets, above 9,700.
But investors were careful about chasing the benchmark too aggressively as they expect profit-taking and technical selling after a jump of more than 6 percent since the start of last week, its best weekly performance in a year.
"A liquidity bubble is emerging in global markets, and investors increasingly believe Japanese stocks, which have lagged behind, will also reverse course," said Kenichi Hirano, operating officer at Tachibana Securities. Hirano said the main impetus behind the Nikkei's gains remained short-covering by foreign investors.
"Individual investors likely have begun to pay attention to signs of the change, but they haven't jumped back into the stock market yet as they can't really grow bullish overnight after having been pressured to sell up until now," he said.
The Nikkei average ended the day up 106.93 points at 9,732.92, its highest close since July 28.
Upward momentum picked up after the Nikkei broke through a high of 9,716.92 reached on Oct. 7, lifting it to an intraday peak of 9,737.01.
The broader Topix gained 0.8 percent to 841.74.
The Nikkei's technical trend brightened after it broke through its 25-day moving average of 9,430 as well as its 26-week moving average of around 9,530 last week, which some analysts now see as support.
Its next target would be an intraday high of around 9,750 reached in early August and further resistance is seen at its July peak of around 9,800.
"We are seeing some resistance, but sentiment towards the Nikkei is strong. After the current level of 9,700-9,800 is broken, the market will test the Nikkei towards 10,000," said Hideyuki Ishiguro, a supervisor in the investment strategy section at Okasan Securities.
Market players have said last week's rally was largely due to short-covering of futures by foreign investors and advances for resource shares as hopes for more liquidity spurred investor risk appetite.
But Tokyo still lags other stock markets, particularly due to worries about the impact of the strong yen on corporate earnings and a fragile economic recovery.
Market players also cite ineffective measures against deflation, a lack of political leadership and lacklustre growth prospects as being behind the Japanese market's underperformance.
In contrast to the Nikkei's three-month high, U.S. stocks have surged back to levels last seen before Lehman Brothers' collapse in 2008.
"We are watching whether there are more strong economic indicators from the United States. More strong signs would push up the dollar and encourage inflows into Japanese export-related shares," Ishiguro said.
A weaker yen has also helped the market. In Monday Asian trade, the yen was little changed from Friday at 81.23 against the dollar but it was more than a yen lower than the 15-year high of 80.21 yen reached last week.
Last month, foreign investors were net buyers of Japanese stocks to the tune of about 463 billion yen ($5.7 billion), while retail investors sold a net 244 billion yen worth, Tokyo Stock Exchange data shows.
Still, analysts say that although Japanese stocks have benefited from a recent surge in global equities, their standing in the world remain relatively weak.
Fund trackers EPFR Global say that nearly $70 billion net has flowed into the emerging market stock funds they monitor over this year, close to half of it since August.
For a graphic showing money flow into emerging markets, please see: http://r.reuters.com/hep83q
RESOURCE STOCKS UP
Resource-linked stocks rose on higher commodity prices as investors took a surprisingly robust U.S. jobs report as a hint that the economy was in better shape than previously thought.
U.S. non-farm payrolls figures released on Friday showed a solid rise of 151,000 for October, the first gain since May and more than double economists' expectations.
Gold hit a record peak on Friday and industrial metals and oil pushed higher.
Sumitomo Metal Mining Co climbed 2.3 percent to 1,410 yen and Mitsui Mining and Smelting gained 2.7 percent to 263 yen. Trading firm Mitsui & Co rose 2.5 percent to 1,352 yen.
Shares of Credit Saison jumped 5.5 percent to 1,238 yen after the consumer credit firm raised its full-year net profit forecast to 12 billion yen ($148 million) from 9 billion yen, partly due to cost cuts.
Exporter shares climbed, with Honda Motor Co up 3.3 percent at 2,975 yen and Tokyo Electron gaining 2.9 percent to 5,060 yen.
But Resona Holdings continued to fall, dropping 8.6 percent to 468 yen, after the bank announced plans to raise up to $7.4 billion in new shares to repay government bailout funds.
Trade slowed on the Tokyo exchange's first section, with 1.67 billion shares changing hands, down from a one-week high hit on Friday above 2 billion shares.
Advancing stocks outnumbered declining ones by 3 to 1. (Editing by Chris Gallagher)