Given that we know that thoughout recorded history people have made stories like that up about the community of the same human species over the next hill, it may be not-too-farfetched, but it is also a wildly unnecessary conjecture.
I'm not sure about genetic memory, but human oral tradition is very old, and while I haven't heard about any evidence suggesting it predates modern humans, I wouldn't be surprised if there are stories that turns out to be as old as human language is.
https://commons.wikimedia.org/wiki/File:Pachycephalosaurus_w...
If you're in a pre-civilized, just-barely-scraping-by survival mode, you'd probably conclude: (1) this thing was a monster, and if it lived here I'm not safe. (2) This thing must have been killed by something worse, and if it's around I'm really not safe.
Some guy with a sword kills a big croc, which is a good feat! Yet each telling the croc is bigger, more fierce, especially as the alcohol flows.
His grandkids hear the story too.
Imagine finding a 12 foot long skeleton in a cave, or just a skull of an impossibly large animal, of course it’s a dragon!
Some ancient armies used long cloth bags as flags or banners, to impress the enemies or maybe to signal the position of themselves for the allies to see. They filled the bags with hot air and the bags rose to the sky as contemporary balloons.
Imagine how it looked from the enemy side: an army is approaching and long snake-like things are flying about the mass of people. And you can glimpse some fire at the end that is close to the ground. Could it be a creature that breaths fire? And occasionally these things detached and flew up to the sky. Perfect dragons.
Using occult chronology, Tolkien's world corresponds to the Atlantis period (the same Atlantis described by Plato). Tolkien took most of the interesting bits from different epochs and compressed them into one short story. The tall people (2x taller than us) in his story are the atlanteans, Saruman and Gendalf must be Narad and Asuramaya and orcs are creatures made by the evil faction during the late Atlantis when the civilization was on decline. The records say, though, that the bad guys won at the end and the atmosphere during that final chapter was shown in the Prometheus movie. All movies and books, though, present a rosy version of orcs and other evil stuff from the records - an accurate picture would be unthinkable even in the book format.
He needed no popular book of the occult; he had read all the original myths in their original ancient languages. There is plenty of scholarly work describing his sources, and he wrote his own essay on it, though it's more conceptual than about primary sources: On Fairy-stories.