TrueCrypt is a great, open source, free encryption tool for thumb drives. I have been using this for several months now on my 2gb thumb drive, using AES encryption, and it has been working flawlessly. I created mount.bat and unmount.bat batch files to hook it up and take it down. I couldn't get autorun.inf to do this automatically when I connect the drive on Windows XP, maybe I will come back to that when I have time. Highly recommended.
Some good links for how to set it up and configure a mountable thumb drive:
http://glosoli.blogspot.com/2005/09/encrypted-thumb-drive-and-autoplay.html
http://lifehacker.com/software/portable-applications/hack-attack-quicklaunch-your-usb-workspace-182792.php
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