Could you check out this example I created and let me know if that was your intended effect? I'm still not entirely certain I'm grasping everything you're trying to do. Basically, you have an initial list. You want the image in each one to fade in/out when the link is hovered. You then want to be able to add a list item to the list and have the hover effect still work. Using the most recent JQuery, you could use the new .live() event handler like in my example, or you could change it back to a bind and use the hover event instead of mouseover and mouseout.
http://shaneriley.info/deletefade
