* Mill buying erases early losses
* China's Zhengzhou cotton drops for 4th day
* China should shift monetary policy - c.bank researcher (Adds closing U.S. prices, writes through)
NEW YORK, Nov 15 (Reuters) - U.S. cotton futures finished marginally higher on Monday to end a three-day losing streak as trade and suspected mill buying wiped out initial losses, brokers said.
Prices of the material had stumbled overnight due to weakness in China's cotton market, pressured after a central bank researcher there said Beijing should move toward a more prudent monetary policy and guard against loose money risks.
The U.S. cotton market rallied last week to an all-time high, but the threat of monetary tightening by No. 1 consumer China deflated fiber contracts on Thursday and Friday.
Benchmark March cotton on ICE Futures U.S. rose 0.02 cent to $1.342 per lb on Monday, having moved from $1.3499 to $1.2838 -- the lowest for the second-position contract in 12 days.
Volume traded in U.S. cotton reached almost 45,400 lots, about a quarter above the 30-day average of 34,200 lots, preliminary Thomson Reuters data showed.
Cotton prices had been rallying since July, hitting 150-year highs last Wednesday due to mill demand from China, tight stocks and fund buying by investors who saw the material as undervalued.
Despite the near-20-percent fall in values last Thursday and Friday, the U.S. cotton market is still the top performer on the Reuters-Jefferies Commodity Index, up over 75 percent in the year to date.
In China, the Zhengzhou Commodity Exchange's May cotton contract last traded at 28,120 yuan per tonne, down 1,225 yuan on the day but off a session low of 27,150 yuan.
The threat of a tighter monetary environment in China undermined the market in early dealings.
"Any tightening by China will have a substantial impact on those markets that are at the extreme range of trading," said Garry Booth, a trader with MF Global Australia.
"Cotton is particularly vulnerable to any rate rise in China or any change in China's policy," he said.
Fundamentally, analysts said cotton's outlook remained strong because of high demand by mills and tight supplies would mean strong prices into the spring of 2011.
"The fundamental picture still hasn't changed," said Lou Barbera, cotton specialist for brokerage VIP Commodities.
He added that cash cotton activity in markets such as China remained robust.