How can I cluster a graph in Python?

In SciPy you can use sparse matrices. Also note, that there are more efficient ways of multiplying matrix by itself. Anyway, what you're trying to do can by done by SVD decomposition.

Introduction with useful links.

Why not use a real graph library, like Python-Graph? It has a function to determine connected components (though no example is provided). I'd imagine a dedicated library is going to be faster than whatever ad-hoc graph code you've cooked up.

EDIT: NetworkX seems like it might be a better choice than python-graph; its documentation (here for the connected components function) certainly is.