I have tried to burn the uno bootloader a number of times. All apparently successful (no error LED, heartbeat LED ok, everything fine) but it didnt make any difference.
However I was just reading another similar thread here and saw James C4S talk more of knock off boards being Duemilanove and in combination with his suggestion above (of trying different selection under board type), I decided to burn the Duemilanove bootloader.
That definitely made a difference. The pin 13 led now flashes slowly, longer off than on, but still within 1-2 second cycle. I guess that shows my bootloader burning is working, and from above, my loopback is working, what else could be going on?
Even with the Duemilanove bootloader I still get the same error, even switching between Duemilanove and uno under board selection when uploading sketches.