* Iron ore benchmark falls for 4th time in 5 days
* Chinese mills keeping minimum level of ore stocks -trader
SINGAPORE, July 5 (Reuters) - Spot iron ore prices dropped and bids were low and scarce on Thursday as most Chinese steel producers sat out of the market, limiting their stocks of the raw material as they weather sustained weakness in demand for steel.
Buyers were few and far between, traders said, suggesting iron ore prices may be heading for further declines, after a spike on Tuesday largely driven by a rise in prices for an Australian iron ore grade.
Benchmark iron ore with 62 percent iron content .IO62-CNI=SI eased 0.2 percent to $135.10 a tonne on Wednesday, based on data from Steel Index, its fourth decline in five sessions.
Iron ore rose 1.4 percent on Tuesday, after miner Rio Tinto Ltd sold 61.5-percent grade Pilbara iron ore fines at higher than market rates, partly as the market has seen limited availability of that particular grade in recent months.
The outlook for China's steel sector remains dim as demand is slowing along with the overall economy, traders said.
"It is difficult for us because we have ready cargoes at the ports and prices are decreasing because mills are reluctant to buy," said an iron ore trader in the port city of Rizhao in China's eastern Shandong province.
Small and medium-sized steel mills in China are keeping a minimum level of iron ore stocks, equivalent to 10-15 days of use, because the steel market is "really bad", he said.
His company is holding off on the sale of 80,000 tonnes of iron ore it has in stock as the current market rate, for at least half that volume, is around 50 yuan ($7.88) per tonne less than the price at which it was bought, he added.
"We're waiting for the market to get better, but I don't see any sign of that happening this month."
Steel prices in China, as measured by rebar futures in Shanghai, are down more than 2 percent this year, as demand in the world's biggest steel consumer weakened. That has prompted some steel mills to curb output to cut losses that reached about 1 billion yuan in the first quarter.
"I don't see any chance of iron ore prices to improving a lot this month as steel demand remains tepid," said an iron ore trader in Shanghai.
But prices may recover later in the year if China moves to further stimulate the economy, including through measures such as boosting lending to steel mills, the trader said.
The most-traded rebar contract for October delivery on the Shanghai Futures Exchange was little changed at 4,087 yuan a tonne by the midday break.
Shanghai rebar futures and iron ore indexes at 0457 GMT
Contract Last Change Pct Change
SHFE REBAR OCT2 4087 -2.00 -0.05
PLATTS 62 PCT INDEX 137 -0.75 -0.54
THE STEEL INDEX 62 PCT INDEX 135.1 -0.30 -0.22
METAL BULLETIN INDEX 135.99 +0.06 +0.04
Rebar in yuan/tonne
Index in dollars/tonne, show close for the previous trading day
($1 = 6.3477 Chinese yuan)