Cloth is one of the two resources used by tailors (the other being leather). It can be farmed and crafted by any player; one need not be a tailor. This is fortunate considering cloth is commonly cut up by fighters to create bandages.
Cloth will not always readily stack, even with piles of the same color; the "combine cloth" option on a tailor's Sewing Kit menu will stack like-colored cloth into a single pile. It should be noted that a newly purchased dye tub can be used to effectively remove any color.
Many articles of clothing can be chopped up into cloth using Scissors or a Salvage Bag, but this is a poor method to gather a large quantity. It is typically much faster to either buy it from an NPC or create your own.
There are two primary sources of raw material that can be crafted into cloth: Wool from sheep, or cotton from a field. Originally, flax was also to have been a source for cloth. Cotton produces twice as much cloth as wool does.
A player must obtain a bladed weapon with which to remove the wool from a sheep. A Skinning Knife is a good choice and can be obtained from local NPC Blacksmith vendors in town. While Yew continues to be a good location for finding sheep, the farm area east of New Haven now sports several flocks that are ripe for the shearing. Double-click your bladed weapon and target a live sheep. If it has enough wool to collect, the Pile of Wool will be transferred directly to your backpack.
Dead sheep can also be shorn, however the bloodied wool is of inferior quality and won't produce as much cloth.
Up to five cotton plants can be found growing at the fields near Moonglow and Skara Brae (ten each for Trammel and Felucca, up to twenty at once per shard). To harvest, double click the plant and a Bale of Cotton will appear on the ground that you may pick up. After harvesting fields will slowly re-spawn more cotton plants.
Spinning & Weaving
Use the cotton or wool on a spinning wheel to produce thread or yarn respectively. Cotton provides six units of thread, while wool only gives half this number. If you do not have a wheel in your house you can find one in most town tailor shops.
If you do not have a wheel and/or loom in your house you can find each in most town tailor shops.
Reward cloth consists of 5 levels of rarity, each being the result of turning in Bulk Order Deeds (BODs) from a tailor or weaver NPC. The cloth reward system is simple; the harder the BOD completed and returned, the better the reward cloth received.
Tower of Roses has a decent chart that shows which type of BOD results in each color of reward cloth.