I just tried this plugin on my site, http://www.taprootradio.com.
My site had about 1200 posts and around 680 images that were hosted on blogspot. The reason for this is I migrated from blogger to WP by exporting the blogger content to an xml file, converting to a WXR file using a tool I found online, and then importing it into my WP site. That worked except that it left all the images over on blogspot.com. So this plugin is exactly what I needed.
I am on WP 3.2.1. and am using version 1.4 of the plugin at this site:
http://www.bbqiguana.com/wordpress-plugins/add-linked-images-to-gallery/ I think this is the same plugin mentioned above.
I can report that the plugin seemed to do the job, but there's a couple of gotchas.
First, because I had a large number of posts, the request seemed to time out. I don't think this had anything in particular to do with the plugin. I think my hosting company had some sort of setting that timed out the request because it took too long. Fortunately, I just went back into the dashboard and started the plugin again and it seemed to pick up where it had left off just fine. I had to to this 2 or 3 times before it got all the way through all my posts.
The second gotcha is that at first, it appeared that the plugin didn't work! I went to two or three random posts and clicked the image. The image was linked back to the external image. I had expected the link to go to the local stored image. So I panicked at first. But when I went into the post editor and pulled up the properties, I saw that in fact the image WAS sourced from the local copy of the image, but the image link was set to the external copy of the image. That might have been an artifact of how I got my content into WP in the first place. Not sure.
I would have preferred that the image link go to the local copy of the image in order to totally divorce it from the external image.
But it's not a big deal. The main objective seems to have been accomplished with no problems!
Thanks to Randy Hunt for such a useful plugin!