Unable to locate a suitable developer disk image. Reinstall the iPhone SDK.
And, maybe you do reinstall it, but the message persists. Aaand, when you compile your software, you get a CodeSign error:
No certificate found in keychain for code signing identity 'iPhone Developer'
The problem is that the huuuuuge iPhone SDK 2.1 installer doesn't come with the iPod touch 2.1 firmware image. Suck. Fear not, though: All you have to do is force iTunes to do a firmware restore, which will download the appropriate image. On next launch, Xcode will find it and everything will work great.