I decided I wanted to do this a couple of nights ago and now I've come up with a method, it's not really complicated but can be rather time-consuming depending on how large your library is.
I have around 800 albums with attached album art and it took at least an hour, granted most of that time is spent watching your computer doing all the work for you.
The process requires you to download some free applications (links supplied) and you also need a new-ish version of Photoshop (I use CS3) although I'll show you an alternate way of getting basically the same results with Google's free digital photo organizer, Picasa2.
So, for Windows only at the moment, but I'm sure some Mac user can come up with an easier and cooler way to do this. Damn you, I'm switching soon anyway.
More advanced users can check out Step 7 right away for a quick rundown.
Step 1: Locating your iTunes album art
There's several ways to go about this; you can import the covers automatically from the iTunes Store or you can painstakingly do it by hand for every album.
- By hand
I imported all mine into iTunes by hand, partly because I'm kinda picky and want them all the same size but mostly because I listen to weird electronic music that's just not available in the iTunes Store, forcing me to find the cover art from Discogs.com, Google image search and elsewhere.
Anyway, I will assume you have at least some album art in iTunes (the more the better) and move on.
So let's locate the images on your computer.
The problem, and the one thing that makes this instructable even worth sharing to begin with, is that the images are not readable by Photoshop as is and that they're all spread out into hundreds of strangely nested folders with strange names.
Therefore, we need to decode them and copy them all into one place.
The default folder for your artwork should be in "My Documents\My Music\iTunes\Album Artwork\Local"
If you can't find it there just do a search for the folder "album artwork" on your C: drive.
If you navigate around a bit from here you'll notice that it's very messy, so we have to find all the *.itc files (those are actually just renamed png images with some extra header data) that are thrown around in the myriad of folders and copy them into a new folder so that we can manipulate them without destroying your iTunes setup.
From the Local folder, click Search in your Explorer bar (CTRL-F) and search for any file that has "itc" in it's file name and after a while you should be presented with a list of all the cover art files.
Now, make a new folder somewhere else, maybe on your desktop, Select All the files (CTRL-A) and copy them into your newly made folder.
Make sure you copy the files, don't just move them or you will mess up your iTunes library!