NEW YORK, Aug 3 (Reuters) - Cotton futures finished
Wednesday with steep losses, though managed to remain above the
20-day moving average, as some investors sold the fiber to take
profits following an advance that analysts said was likely won
too quickly.

'I didn't think supply and demand issues were behind the
rally earlier this week. This is where we draw a line in the
sand and see whether (support levels) hold,' said Sharon
Johnson, senior cotton analyst at Penson Futures in Georgia.

'If not, the run up was more of an anomaly,' she added.
Key December cotton futures on ICE Futures U.S. was
down sharply at the end, falling $2.69, or 2.52 percent, to
$1.0416 per lb.

Setting an inside day on technical chart, a lower high and
a higher low, which meant it failed to return to the near
three-week peak set a day earlier.

Volume in the benchmark contract was a moderate 7,460 lots,
almost half the 13,679 lots traded as December cotton rallied.

Across the board, preliminary volume at 10,144 lots stood
well below the 16,834 lots traded on Tuesday and 30.6 percent
below the 30-day average, according to ICE Futures U.S. data.

Open interest in the cotton market increased to 144,447
lots as of Aug. 2, exchange data showed.

Some investors may have been hasty in their purchases of
cotton, along with other agricultural commodities, following
Tuesday's passage of a measure to raise the U.S. debt ceiling
and address the huge deficit, and decided to take profits off
the three-week highs reached in the rally.

At the same time, Johnson said, the softer prices may leave
room for more buying going forward.

With mixed factors tugging prices in both directions,
Thursday's action may be critical to cotton's near-term fate.

'You had a sort of one, two, three punch. You had concerns
about the debt ceiling deal and further easing by the Federal
Reserve. You had a technically oversold condition. And, you had
a seasonal pattern of a preharvest low followed by a rally into
August,' said Johnson.

At the same time, drought conditions in Texas and other
cotton growing regions in the United States, that the U.S.
Department of Agriculture estimates will destroy about 30
percent of the crop, could keep December futures prices
supported.

Next week, the USDA will release its monthly production
report with updates on how much of the U.S. crop has been
destroyed by hot and dry weather.

Meteorlogix, DTN's commercial weather service, said,
'extreme heat and drought will have a major impact on cotton
production across West Texas this year with virtually no
dryland production and sharply reduced irrigated production.'

Elsewhere in the world cotton is plentiful, however.
On Thursday at 8:30 a.m. (1230 GMT), USDA will release its
weekly export sales figures.