* Nikkei up 0.5 pct in thin volume, bright outlook helps
* Stocks weighed down as yen slowly extends gains vs dollar
* Volume up slightly at 1.3 bln shares, but still low
By Chikafumi Hodo
TOKYO, Dec 29 (Reuters) - Japan's Nikkei average advanced 0.5 percent on Wednesday as investors bought on dips amid hopes that Tokyo stocks will stay bullish entering 2011, though a stronger yen limited strong follow-through buying.
Stocks started lower due to the firmer yen, but they regained strength by late morning as Chinese shares edged higher and bargain-hunting emerged in thin trade before the year-end holidays, analysts said.
Market participants were upbeat heading into next year, as Japanese stocks are still cheap compared with those in other developed markets even after having gained nearly 10 percent in the last quarter of 2010. The index is still down 2 percent for the year.
"There is no solid reason to sell Japanese shares actively as the outlook for the market is still bright. Many investors are keen to hold on to their buy positions," said Mitsushige Akino, chief fund manager at Ichiyoshi Investment Management.
"Investors will be entering 2011 on a bullish note, so I think there is still a chance for the Nikkei to test 10,500 in the near term."
The benchmark Nikkei closed the day up 51.91 points at 10,344.54.
The broader Topix index gained 0.6 percent or 5.18 points to 908.01.
Trading volume picked up slightly by the close after it had fallen to the lowest since December 2008 the previous day.
A total of 1.31 billion shares changed hands on the Tokyo Stock Exchange's first section, up from a two-year low of 1.08 billion shares on Tuesday, but turnover was still well below last week's average of 1.64 billion shares.
Market participants may be still keen to push the Nikkei above last year's close of 10,546.44 by the final trading day on Thursday, analysts said.
A Reuters poll showed earlier in the month that Japanese stocks are likely to end next year roughly 17 percent above current levels, helped by a recovery in the U.S. economy and robust performances from emerging markets.
Many foreign players stayed on the sidelines, but they have been active buyers the past few months.
Finance Ministry data showed last week that foreigners' net purchases of Japanese stocks hit their highest since April, rising to a net 224.4 billion yen in the week to Dec. 18.
Foreign investors were net buyers of Japanese stocks for a seventh straight week, with total net purchases during those seven weeks of 1.05 trillion yen.
Japanese shares are trading around 1.1 times book value, with Greece, Italy and Ireland the only developed markets trading at lower valuations, according to Thomson Reuters' Starmine data.
YEN STRENGTH
The near-term trend for Japanese stocks has been hurt by the yen's recovery.
The dollar was down 0.2 percent at 82.24 yen in early Asian trade after falling on Tuesday as low as 81.81 yen, its lowest since November.
Investors were also cautious about taking fresh buy positions in Japanese shares after seeing downbeat U.S. consumer confidence data the previous day.
U.S. consumer confidence unexpectedly deteriorated in December, hurt by increasing worries about the labour market, while the price of U.S. single-family homes fell almost double the expected pace in October.
"The market is turning nervous as the yen is regaining strength. Weak U.S. economic indicators released yesterday are also making the market cautious," said Hiroaki Kuramochi, chief equity marketing officer at Tokai Tokyo Securities.
But the strength in oil prices, with the key U.S. crude oil futures staying near two-year highs, pushed up shares of resource-related firms and trading companies.
"Activity is slowing down in overseas markets as well, but investors' risk-taking appetite isn't slowing as we can see commodities prices are rising and lending support to equities," said Hideyuki Ishiguro, supervisor at Okasan Securities' investment strategy section.
The 19-commodity Reuters-Jefferies CRB index settled at its highest level since October 2008 on Tuesday after oil, soybean and wheat prices reached peaks seen around the same period. Raw sugar raced to a 30-year high.
Among trading houses, Itochu Corp rose 1 percent to 838 yen and Mitsui & Co Ltd gained 0.7 percent to 1,343 yen.
Hitachi rose 2.4 percent to 425 yen after the Sankei newspaper reported the company is likely to clinch a contract for a UK rail network project as early as the start of next year.
Agility Trains, a consortium consisting of Hitachi and British infrastructure project manager John Laing, have been the preferred bidders on the contract.
Separately, the Nikkei daily said that Hitachi, the country's biggest electronics conglomerate, would review the operations and its capital relationships with a quarter of its roughly 40 businesses. (Additional reporting by Taiga Uranaka; Editing by Chris Gallagher)