By the way faction is an issue, if the dverges aren't neutral(?) the smith won't take the axe. Anyway check the lava pit around the dorf fort the smith swims there for some odd reason (atleast it did for Spede)
Some things from my head considering this epic (not 100% if they're correct) you need to wear the gem you got from the smith, you need to use the axe or 'talk' to it. If i remember right you can't give the axe before the gem or if you don't wear the gem, sorry it's been a looong looooong while