NEW YORK, Jan 6 (Reuters) - U.S. cotton ended down about 3
percent on Thursday, after rising by almost the daily limit on
speculative buying before falling as much on selling related to
a rebalancing of cotton holdings by commodity indexes.

'It was an interesting day in cotton where we traveled over
nine handles,' Mike Stevens, an independent cotton analyst in
Mandeville, Louisiana, said, using market jargon to describe
the volatile session.

Benchmark March cotton contracts on ICE Futures U.S.
closed down 3.98 cents, or 2.7 percent, at $1.4122 per lb.

The contract neared its four-cent trading limit to set a
one-week peak at $1.4909. In later trading, it fell almost four
cents to hit a session low of $1.4120.

Stevens attributed the choppy session partly to a mixed
reading of latest weekly export data for cotton, which showed a
net drop in sales.

'At first blush, people took the report as bearish. Then
some got thinking that this were sales from the old crop and
the market's already in sharp deficit for new supply. That
popped the market back up.'

But as the session progressed, selling pressure re-emerged
as index funds started to rebalance their cotton holdings to
align with new weightings for 2011. A broad decline in outside
commodity markets also did not help.

Index funds will be paring risk from cotton and other
overly-weighted agriculture markets and adding exposure to
natural gas and crude oil under the rebalancing which runs
between this week and next.

Investment bank JPMorgan Chase has estimated that nearly
14,000 cotton contracts could be offloaded under the exercise,
putting immediate pressure on cotton despite its strong
fundamentals over the longer term.

Another but smaller bearish factor for prices on Thursday
was the announcement by CME Group that it will raise
from Friday margins for cotton trading on the Chicago Board of
Trade -- a cotton market far less less liquid than the one on
ICE.

Some traders think the liquidation pressure over the next
fortnight could take ICE's benchmark March cotton to below the
key $1.30 mark.

But some market bulls are eyeing record highs above $1.60
per lb, saying this could even happen in the near term if
supply fears worsen from floods in Australia and dry conditions
in the U.S. cotton belt of Texas.

March cotton peaked at $1.5912 on Dec 21, capping a streak
of highs last seen during the 1861-1865 U.S. Civil War -- a
time when the President was Abraham Lincoln.

Many in the U.S. cotton industry who have grouped for an
annual conference in Atlanta this week appeared cautiously
optimistic that high prices will persist in 2011.

But they also said a lot will depend on what China, the
world's biggest producer and consumer of the fiber, will do,
especially after it drew down state cotton reserves.

China could raise cotton sowings and output in 2011, but
its activity in the area may be limited if it opts to
concentrate on increasing food output and the economic policies
it adopts, some participants to the Atlanta conference said.