Reading Tolkien I had a compelling vision af how Glaurung, the first dragon, was 'made'.
I imagine that on some high cliff up on Thangorodrim Morgoth and his Balrogs had a great reptile bound with heavy iron chains. There, under the dark, starless sky, they would chant a long and powerful spell, summoning a fire spirit of the kind that was corrupted by Melkor in ages past. By his crafts, Morgoth would then command the spirit to possess the struggling creature. When it had successfully done so, the reptile, now Glaurung the father of dragons, could feed on noldorin thralls growing ever larger and more cunning.
As for the dragon's fire beeing magical, I think it depends on what you mean by magical. A fire-breathing great lizard with a mind far more powerful than a man's is certainly a 'magical' creature, I would say. The fire itself is merely very hot, I imagine. I also think that the dwarven armours could withstand dragons fire to a certain degree, and from some distance. If a dragon blasted a dwarf from point blank range he would no doubt fry like a marshmallow.
