* Spot contract down more than 12 percent from March high
* May delivery expected to be small - broker
* Open interest down as investors liquidate long positions
NEW YORK, April 23 (Reuters) - ICE cotton fell to a nearly two-month low on Tuesday as investors were seen continuing to liquidate long positions ahead of spot contract expiry, taking profits following a rally to a one-year high last month.
The most-active July cotton contract on ICE Futures U.S. closed down 1.05 cents, or 1.2 percent, settling at 85.10 cents per pound.
The price fell as low as 84.85 cents per lb, the lowest level since late February, in late-session trading as cotton continued its decline from highs reached last month during a speculator-driven rally.
The spot May contract fell more steeply on Tuesday, settling down 1.65 cents, or 2 percent, at 82.68 cents a lb, down more than 12 percent from a high of 93.93 cents a lb touched on March 15.
"There's not a lot of trading today, but what we're seeing is the long liquidation out of the May contract. The pressure is on the longs, they're the ones running for cover," said Knight Capital's cotton specialist, Sharon Johnson.
The May/July spread widened to 2.42 cents a lb from 1.82 cents, putting the second month contract at its highest premium to the front-month contract in more than a month.
Pressure from May liquidation extended into the most-active July contract, dealers said.
Open interest has fallen steeply ahead of the May contract's expiry on May 8, with first notice day for delivery of cotton against the contract on Wednesday.
It has declined in each of the past seven sessions, with dealers saying some open interest has been lost during the roll out of the May contract. Investors were seen taking profits following a speculator-driven rally that drove cotton prices up 18 percent during the first quarter.
Noncommercial dealers have dialed back a bullish position in cotton futures and options from a five-year high reached last month, according to U.S. government data.
May cotton has fallen almost 12 percent from a one-year high of 93.93 cents a lb touched on March 15 amid the liquidation.
Exchange stocks continued their climb, reaching 498,497 bales on Monday, according to ICE data, the highest level since June 2010.
Trading volumes were below average on Tuesday, at about 21,000 contracts, compared with a 30-day average of about 24,000, preliminary Thomson Reuters data showed.
Dealers said they expect U.S. weekly export data to continue to be strong, despite expectations of government sales in China and India. The moves by the world's largest producers to sell from state reserves could further pressure prices.
India is expected to start releasing its stocks on Friday.
Cotton's first-quarter rally was underpinned by solid demand and a sense of tightening global supplies outside China.
While the world is projected to hold record global stocks by the end of the crop year through July, more than half of those are expected to become part of China's inventories and are considered unavailable to the global marketplace.
Beijing began building its reserves in 2011, paying above global prices to support farmers. (Reporting by Chris Prentice; editing by John Wallace)
