I had this problem when I got my new iPod touch last week. You will need to 'restore' your iPod with iTunes before things will work. There is an OS dmg file that Xcode is looking for and it doesn't exist on your machine. You wouldn't otherwise need it because your iPod OS is up to date. Choosing 'restore' in iTunes will download this latest OS dmg file and then Xcode will be happy. I wish it had better error messages.
And about the link, yes, you need to make a softlink like this:
Code:
cd /Developer/Platforms/iPhoneOS.platform/DeviceSupport
ln -s 2.1/ 2.1.1
You'll see some other links like that in there already.
