Chinese are dumping steel on international markets, cutting on production while Chinese traders are holding huge stocks of iron ore but now, these small Chinese traders, burdened by costs of holding that inventory, are buckling under lack of any revival in demand and getting rid of their iron ore inventory.

“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. 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,” says an unnamed Chinese trader.

The big trading outfits may hold off on the losses for longer but trends with the small traders are significant because Chinese iron ore market is fragmented into thousands of small ore dealers who are sensitive to price swings and demand.

“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.

Iron ore now goes for about $123 per ton.

But what if these thousands of small traders sink the price sufficiently so that the big boys would have to rethink as to how wise is to sit on stockpiles of unwanted ore?

If big Chinese traders are to follow the small guys, about 100 million tons of iron ore could suddenly get unleashed. At about 62 million tons per month of average iron ore imports, these stocks would account for little less than 2 months of China’s iron ore imports.

Such development could be a huge negative for the likes of BHP Billiton and Rio Tinto because of their large exposure to China and plans to expand their production.

Earlier in the month, for example, BHP announced that it plans to “lift Australian iron ore output by 5 percent in the 2013 financial year, despite risks of cooling demand in top customer China.” In fact, Australia’s Bureau of Resources and Energy Economics sees iron ore experts to rise 10% for 2013.

Now, 2013 is longer way off which gives some room for the Chinese stimulus to pick up steam among steel makers who are, in the short term, unlikely to benefit from the stimulus, at least not until sometimes in Q4. This leaves a 1-2 month vacuum that could unleash some major iron ore selling.

“It is expensive for small traders to hold stocks. 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,” says an iron ore trader with a large state-owned trading company in Shanghai.

We have to see if this turns into an iron ore avalanche.