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Why foreign investors are hot on Nikkei futures

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Koichi Kamoshida | Getty Images

Foreign investors are fueling the Nikkei's rally by purchasing futures rather than cash equities, but it remains to be seen whether they will stick around this time, analysts say.

"Foreign investors are still testing the waters and haven't decided yet whether to commit by buying cash equities," said Mizuho Research Institute (MRI) senior economist Koji Takeuchi. "There was a huge inflow into Nikkei futures after the Bank of Japan's monetary expansion [at the end of October 2014], but that was swiftly followed by a sell-off in December."

Japan's benchmark index is up around 16.3 percent year to date, currently hovering around 15-year highs. The bulk of those gains came since early February with Japanese pension funds buying cash equities, while foreign investors bought futures.

"Futures are easier, lower risk and don't require real commitment," said Sunrise Brokers' Head of Japan and Asian Equities Ben Collett.

Extending the Bull Run

In February alone, foreign investors bought nearly 2.1 trillion yen ($17.3 billion) worth of futures but just 190 billion yen worth of cash equities, according to MRI's Takeuchi, citing Tokyo Stock and Osaka Securities Exchange figures.

The index had soared 118 percent since the run up to Prime Minister Shinzo Abe's re-election in December 2012, sustained by the Bank of Japan's (BOJ) massive quantitative easing program, which was launched in April 2013 and expanded in October 2014.

Meanwhile, the yen fell nearly 50 percent against the U.S. dollar over that period on the back of the BOJ and Abe's efforts to spur the economy, compared to below 30 percent for the Australian dollar and just 0.32 percent for the Hong Kong dollar, which is pegged to its U.S. equivalent.

And so, despite the Nikkei's year-to-date gains, Japan stocks still look attractive for foreign investors in dollar terms, Collett said.

In dollar terms, "the Nikkei is up 9 percent so far this year, compared to 1.4 percent for the Hang Seng and 1 percent for Australia's ASX," he said.

Next resistance line

The next target level will be another 15-year high: the 20,884 level last hit on April 20, 2000.

In the meantime, analysts are bullish about how high the Nikkei can climb from here, even taking into account the likelihood the U.S. Federal Reserve will raise interest rates and trigger a sell-off of stocks later this year.

"It all depends on what the Fed does, but we expect the Nikkei to hit 21,000 by the middle of the year," said Sunrise Brokers' Collett.

The index is likely to hit 23,000 within two years, said Collett, but in the unlikely event the current momentum is maintained for the rest of this year, the Nikkei could reach that level by the end of 2015.