Very nicely done, also enjoyed playing with the various versions you came across along the way. Have to say I'm quite impressed at the performance too. The machine I'm on right now only has Firefox 3.6 on it with its older, slower JS engine and yet your demo runs beautifully. Again, very nice.
Couple suggestions... having drawing while dragging apply a differing effect. Also using click to turn on and off the draw (with a separate clear button somewhere else)