This one is a biggie, clothing simulation at this level has been complicated to do and involved a lot of trickery. This year's SIGGRAPH paper shows the work of a collaboration of Cem Yuksel, Jonathan M. Kaldor, Doug L. James and Steve Marschner.
Their paper describes their way to accurately simulate knitted clothing. Fantastic!
Here some words on the project and some videos, even an implementation in Blender already exists!
Cem Yuksel's Website