I know...I was under the impression that the volume setting wasn't supposed to affect the adapter...only the aux input. Definitely try it because there is a considerable difference in how mine sounds based on how the volume is set on the iPod. I always notice that it sounds bad thru the HK when I take the iPod out of the car (turn the volume down when I go for a run) and then put it back in, forgetting to turn the volume back up.
Oh, and I too have a gen3 iPod, but mine is 20gb.