This is something that makes a lot of sense to me and seems to be a logical development for Apple. iTunes is a massive advantage for Apple and taking it to the cloud would give them such a big selling point in the market it's hard to overstate just how big a jump forward it would be. Your entire content library, available on-demand to any iTunes-aware device with an internet connection with Genius working alongside for new media based on purchasing habbits? Not to mention having the ability to store it all locally if you wanted to? I really don't see how Google or even Microsoft could step up and match that right now, they just don't have the service or relationships or brand name (or combination thereof) that Apple do. Add on a subscription service (which, again, would make a great deal of sense if Apple are moving iTunes to a full cloud solution) and you've got a real monster ready to go.
The problem, of course, is not just the technical side but the content providers. They've been dragging their heels on stuff like this for a while now so it'll be interesting to see what Apple can do to get them to move. If they manage it though this could genuinely be the product that breaks through in the living room of the average consumer, especially if they price point is anything like accurate (plus with that hardware the box could be the size of.... well the size of an iPhone board without the screen or battery, especially if they off-shored the power supply).
I don't think you'll see this for a while though... maybe September at the traditional Apple media event? Would be a HELL of a selling point wouldn't it - iTunes in the cloud, your iPod Touch on wi-fi can access every song, tv show and movie ever created (and available on iTunes) and, oh yes one more thing... here's the same experience for your living room.