* LME/ShFE arb: http://bit.ly/2wZSAEz
* LME zinc stocks down 70 percent since Sept 2015
* Cash to threes zinc backwardation highest since Nov. 30 (Recasts, adds comment, changes dateline from Sydney)
LONDON, Jan 2 (Reuters) - Zinc rose to 10-year highs on Tuesday as the market focused on looming deficits due to falling supplies, but gains were capped as prices are at levels which are likely to encourage investment in new output.
Benchmark zinc was up 0.5 percent at $3,336 a tonne at 1149 GMT from an earlier $3,338.50, its highest since August 2007, before the financial crisis hit demand for the metal used to galvanize steel.
"Demand growth is decent, but not spectactular from a historical perspective, which tells me this is once again a supply side issue," said Bernstein analyst Paul Gait.
"Years of underinvestment have caught up. We could see a further price acceleration in the short term, but current levels should generate sufficient capital inflows to generate new supply to meet demand."
CHINA: Zinc imports by the world's largest consumer jumped to above 573,000 in the first 11 months of last year, up 43 percent from the same period last year.
ENVIRONMENT: China's war on smog cut local output of zinc last year and is expected to again cut supplies in 2018.
STOCKS: Shortages have led to a drawdown of inventories in LME approved warehouses <MZNSTX-TOTAL>, which at 180,975 tonnes are down 70 percent since Sept. 2015. Stocks in warehouses monitored by the Shanghai Futures Exchange <ZN-STX-SGH> at 68,630 tonnes are down 65 percent since March last year.
PREMIUM: Jitters about a shortfall on the LME market have pushed the premium for the cash over the three-month contract to $18 a tonne, its highest since Nov. 30.
WARRANTS: Traders are watching a large position holding between 30-39 percent of zinc stocks and cash contracts on the LME system. <0#LME-WHC>
TECHNICALS: Trendline support comes in around $3,280, while strong resistance is at $3,570, the high from August 2007 and the upper 30-day Bollinger band.
DOLLAR: Overall, base metals were supported by a lower U.S. currency, which when it falls makes dollar-denominated commodities cheaper for non-U.S. firms.
MANUFACTURING: Optimism about Chinese demand was boosted by an unexpected December rise in manufacturing and a pick up in new orders. But higher prices for raw materials and firms cutting staff has fueled concerns about growth.
"The PMIs ended 2017 on a strong note," Capital Economics analysts said in a note. "But if the past couple of quarters are any guide, this may not translate into an improvement in the hard data."
PRICES: Copper slipped 0.4 percent to $7,220 a tonne, aluminum lost 0.1 percent to $2,265, lead rose 1.5 percent to $2,525, tin was flat at $20,025 and nickel added 0.2 percent to $12,785.
(Reporting by Pratima Desai Editing by Jeremy Gaunt)