Is it proper to observe the shabbath, holidays, keep kosher while the conversion is still in progress, even though I am not considered a Jew in the eyes of G-d? What is the best way to respond if someone asks whether I am a Jew or not during the conversion process? Thank you

A candidate for conversion may perform the various commandment, including observation of holidays and kasrut. With regards to Shabbat, one should each week break the Shabbat (i.e. do melacha, like turn on a light, or cayrry something in your pocket where there is no eruv) as an affirmation that the Shabbat is a gift to the Jewish people. The other rules of Shabbat may be observed, as well as recitation of prayers. Generally I believe a person should be honest and forthcoming about status, and there should be no embarrassment attached to saying "I am studying for my conversion" Certainly one shouldn't lie, but in a situation that admitting to being a candidate for conversion might be embarrassing, one can remain silent. If someone asks outright, I believe simple honesty is the best policy.