I'm not sure if the original poster ever got this issue resolved or not, but I'm having the exact same problem. My iPod shuffle is a 1Gig 2nd Generation, and I have all of my music library on an external hard drive. Before connecting my shuffle, I can play all the songs through iTunes perfectly fine, as well as sync them all to my 160GB iPod classic. As soon as I connect my shuffle, iTunes can no longer find or play any of my music, or sync any of it to the shuffle. In fact, it seems to make the external drive disappear from the computer entirely. When I right click My Computer->Explore, the external drive is still there, but no files are shown on it. After disconnecting the shuffle and rebooting the computer, the external drive is back to normal, until the shuffle is connected again.
For what its worth, this is a new problem, only started happening in the last couple months. I've had the shuffle for 2+ years now, and I have been syncing music to it from the external USB hard drive for just as long with no issues. Occasionally, I can sync 1-10 songs to it at a time before the external drive and all the music disappears, but for the last couple of days, the external drive seems to disappear as soon as the shuffle is connected.
Thanks for any help, I only use the shuffle for the gym/bike riding/snowboarding and I know they're fairly cheap to replace now, but I don't want to pay for a newer generation if I'll still have the same issue.