That is correct.
If you used OneCare for backups, you'll still be able to restore from old backups if you use the OneCare Restore tool -
http://social.microsoft.com/Forums/en-US/onecarebackupandrestore/thread/e5d686c8-762b-4b22-bc08-bfb93f911e57,
but you'll need to seek an alternative backup solution.
I don't know why it isn't seeing your external drive, as Windows Backup in XP can write to a USB drive as a valid destination. I recommend posting your issue in the XP forums:
http://social.answers.microsoft.com/Forums/en-US/category/windowsxp
-steve
~ Microsoft MVP Windows Live ~ Windows Live OneCare| Live Mesh|MS Security Essentials Forums Moderator ~