I find this rumor entirely plausible. The people that are really going to want this are those that jog and jump and bang into things. People that can't use a HDD-based player because of disk-access issues. The music that active people want to listen to while doing whatever active activity pleases them is all likely in the same genre.
When I got to the gym, I have an "on the go" playlist on my mini with a bunch of fast, high energy music that I listen to. If I'm not feeling a song, I just reach down and hit the next button without looking at the screen. I'm never running near death on the treadmill and decide to navigate my way through 1000 songs to the "perfect" one. Just leave it on random and hit next until something that motivates me comes on.
This concept of a no-screen flash iPod is exactly what my "gym" playlist is. It'd be just enough to hold a bunch of songs and have the absolute minimum of controls to adjust volume and jump to the next song.
Come to think of it, the biggest annoyance of my mini is that when i reach down to it clipped to my pants, I always accidentally crank the volume WAAAYY up when just trying to switch tracks. If that pic is true, this interface would avoid that problem and would allow one to reach in their pocket or to their clip and just click the previous or next key.
This device is meant for heavy activity, period. iPods are still being sold much faster than they can be built so the market for the current prices and capacities is nowhere near saturated. I don't think this is a cheap way to grab market share, I think it's another way of filling a very specific customer's product desire.
I say this device is perfect without a screen. If you queue up a playlist consisting of only a few hundred songs, chances are you're gonna like them all anyway, so who cares which one it pics. If you want a device for carrying hundreds of albums instead of songs, there are other iPods for that. Bring on MWSF!
-Drew