I'm not 100% why what you are doing is not working, but I can say the following steps work great in CS5 w/ Win7 64 bit:
1) Use the Asterisk key on the number keypad to mark the "beats" of the soundtrack
2) Drag and drop a folder of images or clips onto the "Automate to sequecence" icon
3) The same pop-up "Automate to Sequence" menu you show will come up; I use:
- Ordering = Sort order
- placement = At unnumbered markers
- method = Insert Edit
Also note that your photos or clips need to have a longer duration than where they are being inserted or there will be gaps
Regards,
Jim