Success; I solved it!!!!
The answer is with two parts, no dealing with the registry. One is changing the TEMP variable to D:\temp (or whatever the second hard drive is). The other does involve junction, but you got the wrong directory.
While you got the right directory for where iTunes keeps downloads, that particular file is relatively small and not where it extracts to (where all the space is eaten). The initial dmg files are extracted to C:\Documents and Settings\All Users\Application Data\Apple Computer\iTunes\Temp . "All Users" seems static. The "Temp" part is dynamic (is created at the operation and deleted after) and appears to be hard coded in iTunes 10, so I moved the "iTunes" folder from above to the other drive, then made the junction point to "D:\Temp\Apple\iTunes" (you do where you want; I made "Apple" read only to avoid autodeleting and invalidating the junction. Overkill, but I was trying to work quickly- probably not a good idea to link to a sub off %TEMP%).
Anyway, worked like a charm. The initial extraction of the download went to the linked directory on D:, then the DMG files were extracted in to %TEMP%\$app(n) and the iPod was soon rescued after that.