In order to debate whether or not currently encoded videos from the iTunes music store will work on a rumored device or not, we first must tackle the new rumored device.
So far, EVERYTHING out there is just rumors. Sure, I am willing to be that Apple is working on a video iPod of this type. However, I highly doubt they will release it in April/May when the 5G iPod hasn't even been out for that long. Apple might release it as a 5G upgrade (like the difference between a 4G and 4G photo) but would they really want to do that?
A 1" screen size won't make too much of a difference. If the screen is in the 16X9 format then you have a couple of options. You can either view the video in 4X3 mode meaning that there will be black bars to the left and right of the video, you can stretch the video but this will distort it, or you can digitally zoom in on the video (like the PSP does) making the file appear to be widescreen.
If Apple did release this new 6G iPod then the videos purchased from the iTunes music store would look even more pixelated. They would either have to go back and re-encode everything, they are already re-encoding everything, or just make it so you digitally zoom in on the videos.
I am not saying that Apple is not working on such a device but I am saying that I really doubt Apple will come out with it in April/May just 6 months after the 5G release.
These rumor sites, especially thinksecret, have been wrong millions of times. Thinksecret was the one reporting that Apple would first update their Mac mini and iBook lines with the Intel processors. They also said that the video iPod was coming last year when Apple did away with the iPod photo line and just called them the iPod (the upgraded 4G iPod). They have made many statements about Apple that have come out wrong.
I imagine that Apple will probably release a new 17" MacBook and they might update their PowerMac line with the Intel processors. Who knows? Apple might just come out with new Intel everything. They could also announce their Tablet PC (which we know they made as they have filed patents for it) or maybe make a Pocket PC. This rumored video iPod could in fact be a pocket PC with only a 20GB hard drive.
It just seems pretty dumb to release a 6G iPod 6 months after the 5G and it would also seem pretty dumb to release a iPod where the entire face of it is the screen. iPods are ment to be used everyday, I don't think a 3.5" LCD would hold the test of time by being used every day.
So, there are my opinions.
Don't worry about it.
