You've made a well-reasoned argument. And if I were the type that could "set it and forget it" and not tinker with play/pause, advancing a track or replaying a track, I would agree.
For me, physical button are more important than a touchscreen because of the need to interact with the track being played as well as bouncing around my collection. In some ways, physical controls on a media player have a similar tactile satisfaction as playing records on a turntable.
I've actually gone the opposite as this thread is titled... just yesterday, I received a 30GB 5th Gen iPod Classic (bought it off eBay, $45 w/brand new battery installed). It will be replacing my iPod Touch. (eventually, the harddrive will be replaced by a 128GB SSD)
I find the click-wheel interface very easy to navigate and the scroll-wheel control is more accurate and sensitive in adjusting volume and skimming a track than the sliders found on iOS music player apps.
I make heavy use of smart playlists... something I think most people don't use or know enough about to really put it to good use. This allows me to have dynamic "views" of my collection.
As good as smart playlists are, they're not as good as the "channels" on Sony's SensMe music player for the Playstation Portable.
Having said that, I would love to see Apple take the latest mobile tech hardware and software and make a device that is optimized and dedicated to media playback... an iPod for the next generation.