"iTunes has detected an iPod in recovery mode - Use iTunes to restore"

Restoring iPod to factory setting is the option present in the iPhone which removes everything from the iPhone and makes the iphone brand new wihtout any songs, music files, playlists and other information saved on iPod. People often get confused with Update and restore option present in iPod. Update option reloads the latest software in your iPod with all your files intact as it is but in Restore option iPOd becomes as it has just came from factory as a new iPod and you will not find your previous music files, playlist, podcasts and contacts in case of iPod touch.

Try restoring the iPod if you have a Backup or if you have already restored the iPod to default factory setting and lost all your music files, playlist, itunes configuration, pictures, movies. and really want them back.... Then in that case you require a iPod data recovery software to recover all your files back.

Learn how to restore your iPod to its default Factory setting for iPod, iPod classic, iPod mini, and iPod nano to factory settings:
Check out here: http://support.apple.com/kb/HT1339?viewlocale=en_US

If you want to restore iPod shuffle to factory setting...
check this out http://www.info.apple.com/kbnum/n300701

Before selecting this option be sure and certain that you don't need the songs, videos, pictures present in your iPod. Because if you follow the above steps then you will lose all the data. And if you have already set your iPod to factory settings and now you are searching for files... then its a Bad news that all your files lost as restoration process deletes all the files. But don't worry you can get back all the files back.. try iPod data recovery software and recover all your lost files back. Also file lost because of restoration of iPod.