Here's another thought... connect the PC instead of the iPod and use iTunes to play the music. You confront the same challenges with digital-audio conversion, but you get away from those silly cables (I love silly cables). Check out what the Apple Airport Express can do as a wireless music server providing both a digital signal and an analog signal. You can control iTunes over the home network using Apple's free "Remote" app. It's a very slick system Apple provides.
Apart from the physical connection from iPod or PC as a source through to the analog signal for your speakers, consider the quality of the music files themselves. CD's provide what many consider good quality. When we import CD's into iTunes, we may unwittingly allow iTunes to dramatically reduce the quality of the sound files. The reason is the default settings create lower quality files to save space. There are a couple items of good news about this. First, you can import the CD's and preserve the full quality of the CD sound files. Second, you can choose to use Apple's "lossless" format which takes only half as much storage space as the CD itself and provides perfect (bit quality) reproduction. You can play these much higher quality files by using your PC as the source. While you could put fill your iPod with a few of those large and high quality lossless files, iTunes provides a nifty feature where it will create your basic small compressed file for the iPod (a "lossy" format called AAC - much like MP3), and still retain the high quality version on the PC. Best of both worlds!
Here is how you would set that up. In iTunes under preferences for import settings, select Apple Lossless and check Error Correction. With the iPod plugged in, checked the box that creates an AAC version on the device. Voila, done! Well sort of. If your import settings were not set at a high quality version to start with, then you likely imported your music to a lower quality file. Reimport all those CD's to gain high quality files on your PC (or Mac).
All the fiddling with getting a low level output or even going to an external DAC only make sense if your source files merit the investment. Have fun!
