HANOI/BEIJING, May 22 (Reuters) - A sizzling rally in global copper prices as funds crowd into the market is dampening physical demand for the metal in top consumer China, with buyers bracing for even higher prices.

Copper prices hit historic highs across global exchanges this month, propelled by a short squeeze and funds betting on a copper shortage in the global transition to a greener economy.

Five copper cathode consumers in China, which accounts for about half of the world's demand for the red metal, told Reuters that surging prices have pushed up their costs and prompted clients to scale back orders. Private companies, especially rod makers, were hit the hardest.

"We've cut production by 70%. Many of us now sit on little inventories, cutting or halting operations, but we aren't looking to replenish fearing prices might drop," said one rod producer, who sells mainly to the power sector.

The waning demand was reflected by a deepening discount in spot trading and rising inventories in China.

Adding to the financial stresses, many cathode buyers took short positions when prices hit 72,000 yuan ($9,947) on the Shanghai Futures Exchange, expecting they would never surpass 80,000 yuan due to China's weak economic outlook, said two consumers.

But SHFE copper surged to a record 88,940 yuan on Monday, and many suffered losses from margin calls.

Highly volatile prices are particularly damaging for companies with no hedging capacity. Many buyers in emerging markets, including China, do not hedge.

Some rod producers in the past month even sold their products as lower-value scrap due to weak demand from the power sector, Chinese analysts and producer sources said.

DISCONNECTED FROM FUNDAMENTALS

China's weak copper cathode demand has already been reflected in declines in semi-finished copper products output in March and April.

"Prices are completely disconnected to fundamentals. The macro outlook is tilted to the downside," said analyst Natalie Scott-Gray at broker StoneX.

"Although fundamentals have turned more constructive with a 116,000-ton deficit this year, this is not massively out of balance and does not justify the higher prices," she added.

Financing costs for some cathode buyers have also jumped as their loans are based on the value of the copper.

"Consumption is significantly suppressed. The price might continue to rise, forcing downstream (companies) to accept higher costs," said a China-based smelter source.

Elsewhere, buyers are seeking cheaper alternatives like scrap and aluminium.

"Scrap-fed wire rod is currently more preferable to cathode-fed wire rod ... However, as overall costs continue to rise along with copper prices, orders from scrap-fed semis manufacturers could be hit as well," said analyst Eleni Joannides at Wood Mackenzie, referring to makers of semi-finished products such as copper rods, tubes and foil.

'UNCHARTED WATERS'

Not all copper cathode consumers are suffering, however.

One rod producer reported steady orders from its main clients, state grid companies.

"Projects will not stop just because of high prices, even if it goes to $12,000 or even $15,000. The higher raw material prices will pass on to consumers in the end," the person said.

Copper tube makers are also still enjoying fairly strong demand from air conditioner manufacturers as they ramp up during the March-June peak season to prepare for summer sales.

"Everyday, we still buy copper cathodes because we need to keep producing. We only earn the processing fees," said a tube maker.

"Excluding construction, some other end-use market indicators are looking quite positive and encouraging. Should the copper price moderate, then Chinese consumption might be able to stage a recovery in the second half of 2024," said analyst Jonathan Barnes at Project Blue.

"(However) no one can tell you what will happen to the copper price. We are in uncharted waters," he said.

($1 = 7.2384 Chinese yuan renminbi)

(Reporting by Mai Nguyen in Hanoi and Siyi Liu in Beijing; Editing by Kim Coghill)