South by Southwest heads in the right direction

From a growling singer sporting a pink turban to Sweden's answer to Bob Dylan, the line-up of promising young acts at this year's gathering in Austin, Texas showed that the festival is continuing to set the pace for cutting-edge bands, says Alex Hannaford

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It was billed as the "Guitar Hero Metallica Madness Competition" – a 10pm slot on the big stage. But in what turned out to be the worst-kept secret of Austin's annual South by Southwest festival, the gig masquerading as a platform to launch a new computer game turned out to be Metallica themselves.

"Surprise, surprise," singer James Hetfield growls. "Thanks for letting us come to your party." Then, the band launched into a greatest-hits package.

The truth is, this annual music-industry shindig is not just about young, unsigned bands looking for a record deal any more. Not when bands such as Razorlight, Blur or New York Dolls play – as they all have over the past few years. Or Kanye West, who played an unofficial "surprise" show on the final night of this year's festival. But each year, at the end of March, SXSW is still recognised as the best place to find new talent, and some bands go to amazing lengths to get that recognition – one, Avitia, set up a website called employmyband.com.

Others simply play as many shows as they can. New York shoegazers The Pains of Being Pure at Heart played 10 shows this week and all that tireless hawking around of their catchy tunes looks like it may pay off.

Martin Mills, head honcho at Beggars Banquet records, is here to see The Golden Filter, a New York electro-pop three-piece. It's a weird time of day to catch a 1980s-influenced band more suited to a sweaty New York City nightclub. The keyboard player is captivating as he hunches over his Moog, bashing the keys and then turning to thump two drums next to him in time with band's drummer proper.

At Emo's, King Khan and the Shrines are tuning up on the outdoor stage. This is a stripped-down daytime show but even without his regular horn section, Khan doesn't disappoint. Drummer Johnny Boy Adonis is like a one-man band, playing a kick and snare with his feet, leaving his hands free to wield his guitar while Khan prances about the stage, bare-chested. It may all sound a bit silly (it is), but the music is brilliant: dirty, garagey 1950s pop. In his press blurb, Khan describes his shtick thus: "I began seriously practising voodoo to fulfil my infinite sexual fantasies and when the mojo started working I figured, 'Hey, why not put this to music?'"

In keeping with the theme of interesting drummers, Box Elders' sticksman plays the skins with his right hand while holding chords down on a vintage synthesiser with the other. The Nebraska three-piece are playing a New York Noise party east of I35, the freeway that slices Austin in two. There are a lot of people packed into the beer garden of the tiny venue, and they're spilling into the car park next door. It's not surprising – Box Elders make a beautiful noise.

Quite why Here We Go Magic are playing the same party, though, is a mystery. Two female backing singers complement Luke Temple's haunting Jeff Buckley-esque vocals perfectly. It's experimental, almost psychedelic in places, and while this is passionate, gentle music, Here We Go Magic deserve to be huge.

While waiting for British folkstress Laura Marling to come on, we're treated to a set from Sheffield's Stoney. Singer Mark Stoney is all a-fluster due to "technical problems". But it doesn't matter. Roping in local keyboard and accordion players, and with very little rehearsal, it's all wonderful folky harmonies and shanties.

Just down the road, the Carrera Café is the de facto feeding and watering tent for musicians this year. It's rammed throughout the festival with bands sipping Bloody Marys and playing Connect 4. On Thursday morning, The Proclaimers are sitting in the corner, sunburnt from the Texas sun and laughing and joking with their small entourage.

The music pumping from outdoor speakers at the café next to the Hilton is terrible. Considering this is the first choice for delegates at SXSW due to its close proximity to the Convention Center, Don Henley and Phil Collins are a bad choice. It's lucky that just over the road, 3OH!3 are playing at Stubbs' BBQ. Like New Kids on the Block meets the Beastie Boys (just imagine), they're two boys from Boulder, Colorado, but today they're joined by a drummer and guitarist. It's a great venue for their exuberant, tongue-in-cheek shenanigans. One half of 3OH!3 has long hair and is sporting a John McEnroe-style headband, egging on the crowd. The sun is disappearing and 3OH!3's antics are a perfect segue into the busy night ahead. It's fair to say there's madness in the air: outside the venue there's a group of people chanting and clapping while a couple perform capoeira to the crowd. Two police officers, standing next to their mountain bikes, look bemused at the sheer number of people now flooding the streets around 6th. Austin is usually busy on a Thursday night with students from the University of Texas, but nowhere near the sheer volume that South by Southwest brings. Despite the downturn in the economy, this place is packed.

Round the corner, Stars Like Fleas are just getting started on the small stage at the Habana Bar. Shannon Fields, who also plays in ethereal Brooklyn alt-pop outfit The Silent League, is frustrated with the sound guy, who can't seem to get his act together, but after about 10 minutes, the 11-piece band are ready to go. There's a violin, harp, banjo, horn section, a big-bearded drummer and Fields – who holds the whole thing together, singing and playing guitar and keys. It begins with what sounds like a shambolic, drunken chorus, followed by a cacophony of sound. But Stars Like Fleas make a wonderful noise. It's not a concert – it's an event.

Music blogs had been tipping Obits as a buzz band of the festival. Although they formed only last year, front man Rick Froberg has been on the scene since the mid 1980s, in the bands Pitchfork, Drive Like Jehu, Hot Snakes and Last of the Juanitas. The place is packed, and although half the band look like accountants, they create a great blend of psychedelic rock.

An early slot in the Convention Center café on Friday didn't deter badgeholders who turned up to see Sweden's The Tallest Man on Earth – alter ego of singer-songwriter Kristian Matsson. Wielding an acoustic guitar, his songs are sensitive and eccentric. The online magazine Pitchfork said that Matsson managed to "embody Bob Dylan's effortlessness so well, infusing his songs with a detachment that is neither cold nor alienating."

I bump into Crispin Parry and Danny Ford of British Underground, the organisation that has promoted and hosted British acts at SXSW since 2002. They're raving about a few bands they've seen over the past couple of days: Denmark's Efterklang, whom they describe as "uplifting, experimental, electronic, melodic music not dissimilar to Arcade Fire"; New Hampshire's Wild Light, who, they say, have a sound that's "a bit Eighties"; Austin's Monahans, who play "blue-collar bar music really well"; Paper Route from Nashville ("Green Day meets Postal Service"); and LA heavy-metal band Steel Panther, who are "disgusting and awesome at the same time".

On Friday night, Brooklyn three-piece School of Seven Bells play. Flanked by keyboardist and guitarist twin sisters Alejandra and Claudia Deheza, guitarist Ben Curtis flails around, often hunched over, stabbing at his guitar through a fantastic set. Faultless harmonies and ethereal, dreamy soundscapes take everyone to another place – if only for half an hour.

White Denim, on a little later on the same stage, are an Austin band and also have a considerable buzz about them. It is justified. They're a powerful force live, and singer/guitarist James Petralli looks a little like Jack White as his body moves spasmodically around the stage.

Other noticeable mentions include Bear Hands, a Brooklyn quartet who play their danceable indie tunes (in the vein of Modest Mouse) to a packed Mohawk Patio. And Australian rockers The Grates, who, although they don't have too many memorable songs, have a wonderful front-woman in currently blonde, perennially grinning Patience Hodgson.

My pick of the festival is slightly unconventional: Silverghost, a boyfriend/girlfriend Detroit act featuring Marcie Bolen (ex-Von Bondies) and Deleano Acevedo, aren't actually playing an official SXSW event at all. They were too late applying this year, but they came down to Austin regardless. With her flame-red hair and killer platforms, Bolen rocks out on her guitar while Acevedo produces a meaty sound on his Moog.

These tunes are brilliant and deserve to be heard by a lot more people. What's more, like a lot of people here this week, they look like they're having the time of their lives.