SHANGHAI/BEIJING, July 25 (Reuters) - Sharply falling iron ore prices have pushed small Chinese traders to breaking point, forcing them to sell off loss-making inventory as they give up hope for a market rebound anytime soon.
Big trading firms have the financial muscle to hold on for much longer -- traditionally they have been able to hang on until prices recovered. But even state-owned giants like Sinosteel and Minmetals were selling small amounts of stock at a loss, traders said.
"They are trying to cash out to stem further losses as well as lower risks, but there is little chance they will dump all their stocks," a Beijing trader said.
If large traders were to follow their smaller competitors, some of the nearly hundred million tonnes of iron ore stockpiled at Chinese ports could be unleashed on the market.
That would dent revenues for the top global mining companies, such as BHP Billiton and Rio Tinto that depend on China's steel mills to digest the growing volumes of raw material they produce.
The capitulation by small traders is important because China's iron ore market is fragmented and thousands of small scale dealers play a significant role in price setting.
They reflect spot market sentiment more accurately than big state owned firms, which have more diversified businesses and are normally locked into long-term contracts.
Iron ore prices have dropped sharply in the past two weeks to stand at an eight-month low of $123.60 a tonne. The price slide this year is largely a reaction to a slowdown in demand growth from China, which imports over 60 percent of the billion tonnes of ore shipped globally every year.
"The issue is that small traders are getting their iron ore supplies at around $135 a tonne, so after the iron ore price declined for two weeks they have to sell," said Henry Liu, commodity analyst with Mirae Asset Securities in Hong Kong.
Some traders have sold the most common Australian iron ore, Pilbara fines, at $122 a tonne this week, over 9 percent below the imported price, the Beijing trader said.
Traders traditionally cling on to their stock as long as possible in the expectation that China's long-term demand growth will eventually revive prices.
That explains why stocks have risen sharply. At the end of last week, iron ore inventories at Chinese ports rose to 98.52 million tonnes, according to consultancy Mysteel, just 3 million tonnes below February's record level.
"Quite a lot of the port inventories have been stuck there for over a year, so the main objective for these smaller traders now is to sell whatever they can to stem further losses," said another trader with one of China's top steel mills.
"Few are holding out hopes that the iron ore market would boom again, so they'd rather cash out and use the money for other investments."
Even if the economy picks up pace from now, steel mills are unlikely to see a benefit in demand until at least late September.
Steel demand typically wanes in China in July and August, when summer heat and in some regions heavy rains slow construction activity. Steel demand also slows in the winter months.
In addition, mills and traders have large inventories of steel to work through before they boost output, therefore limiting their appetite for iron ore, industry sources said.
Rebar inventories held by Chinese traders at the end of last week were 26 percent higher than a year ago at 6.71 million tonnes, Mysteel said.
Inventories have increased as steel mills kept output near record levels rather than cut back, due to the expense of slowing or mothballing plants. Steel exports have increased sharply this year.
All that adds up to dim prospects for a near-term improvement in the iron ore market.
"We put a brake on booking materials with our supplier recently, and we have one floating cargo which we are trying to sell, even at a loss," said an iron ore trader in Shanghai.
Highlighting the extent of the sector's troubles, Hangzhou Steel, a medium-sized mill on China's eastern coast, imported at least one shipment of Brazilian ore at over $170 a tonne last April. The trader who sold the cargo to Hangzhou Steel said that ore is still sitting at a port warehouse.
A crackdown on credit to steel traders earlier this year has made it more expensive for smaller traders to finance inventories, adding to the risks of waiting out the downturn.
"It is expensive for small traders to hold stocks," said an iron ore trader with a large state-owned trading company in Shanghai.
"They have to consider port fees, storage fees, logistics and other financing costs. It would have been manageable if demand hasn't been so weak and if the outlook wasn't uncertain. Small traders can either choose to sell at a loss or choose to die."
Iron ore prices .IO62-CNI=SI have fallen nearly 10 percent in the last two weeks to trade at $123.60 a tonne.
To be sure, China's demand for raw materials is still rising each year. But China's economic slowdown has lasted longer and been deeper than forecast earlier this year, forcing iron ore traders to scale back their own expectations of demand.
China imported 366 million tonnes of iron ore in the first six months of the year, up over 24 percent from 2011 and enough to encourage big producer expansion. As prices fall, higher cost and smaller volume producers are likely to feel the impact most keenly. ($1=6.37 yuan) (Editing by Fayen Wong, Simon Webb and Neil Fullick)