* Mills set prices on dips, underpinning market

* U.S. demand expectations lift prices to mid-August highs

* Exchange bales rise to highest since July

NEW YORK, March 14 (Reuters) - Cotton futures advanced on Friday to a second straight weekly gain as mills spied buying opportunities in earlier price drops.

The benchmark May cotton contract on ICE Futures U.S. closed up 0.51 cent, or 0.6 percent, at 92.19 cents a lb.

Commodities markets steaded after a sharp sell-off earlier in the week seen on concerns over economic growth in China, the world's largest user of many raw materials.

Investors have piled into commodities so far this year after the bellwether Thomson Reuters/Core Commodity CRB index saw three straight annual losses.

Spot cotton prices pared gains from a rally to 93.75 cents a lb on Thursday, the highest since mid-August.

Price dips provided opportunities for mills to fix prices on previously booked, or "on-call" sales, providing support and lifting spot prices to a second straight up week.

"The mills are going to take any dip they have to buy the futures," said Nick Gentile, senior partner of commodity trading consultancy Atlantic Capital Partners.

Even so, high prices have crimped buying and prompted cancellations from key buyers of U.S. cotton, USDA data showed this week.

Speculators boosted their net long position in cotton futures and options to 51,301 lots in the week ended March 11, weekly U.S. government data showed on Friday.

The U.S. Agriculture Department (USDA) on Monday boosted a bullish outlook for supply-demand in the United States, the world's top exporter, as it cut the forecast for the country's inventories by end-July due to higher exports.

Even so, exchange inventories on Thursday rose to 261,600 bales, the most since July, according to the most recent ICE data compiled by Reuters.

The USDA's reduced U.S. stocks outlook offset a bearish world forecast as the agency raised its outlook for record global supplies. Global supplies have ballooned due to a government stockpiling program in top consumer China.

Beijing is expected to overhaul the controversial policy this year, a move expected to cut demand for imports and weigh on world prices.

A Reuters poll on Friday showed West African cotton growers will boost output 19 percent in the 2014/15 crop year that begins on Aug. 1. (Reporting by Chris Prentice. Editing by Andre Grenon)