One missing element of Time Machine has been the ability to encrypt the backups. There have been suggestions of ways this can be done to an AFP connected network share using a sparse disk image, but not on a directly connected device. The method below shows how to accomplish this on a local volume.
This video (by Falko Zurell) shows how to do it in detail. The basic idea is to get Time Machine to treat a local encrypted sparse disk image in the same fashion as a remotely mounted backup volume. It's a careful but not particularly difficult procedure, mostly involving Disk Utility and following the precise naming convention that Time Machine uses for remote images.
A brief summary is that you format a new partition on your backup drive and let Time Machine know you want to use it, but don't actually run a backup yet. You create a sparse encrypted disk image and name it by concatenating the hostname and the en0 interface MAC address, and save it to the partition you just created. Then you save the password to your Keychain and put it in the System Keychain so Time Machine can access the image. Point Time Machine to the image will automatically mount when Time Machine does a backup. Complete details of how to do this are in the video (which is about ten minutes long and uses Flash). It's much easier to see than to write down the whole process.
Because I have been looking for this kind of easy how-to for a long time, and I thought it might interest you. All other how-to's I found on the Internet, about the same subject, involved mouting AFP servers, modifying hidden files, etc. This one is the most straightforward way I found to encrypt Time Machine backups.
[crarko adds: The fellow in the video speaks softly so you may want to use earphones to catch all the details. The one caveat I saw in the method is that to do a restore you'd need to mount the disk image manually first, instead of using the normal Time Machine UI. This didn't strike me as that much of a drawback. And obviously, anyone with physical access to both your Mac and the backup drive could get in, since the password is saved to the Keychain.]
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http://hints.macworld.com/article.php?story=20101005033805648