I did find one way to get the contact pictures to work. My guess is that it was not the fastest, but it did work. I actually tried using Gmail and Picasa, but those two really suck. Or at least they are not intuitive.
If you have access to the pictures, copy them to the folder on the phones SD card where the phone stores it pictures when taken. Go into each contact, and select edit. Press on the blank picture Icon and it will bring up your list of photos. Add and save. then sync with Gmail, confirm that that Gmail has the photos saved for the contacts. I then went back into the phone and deleted the photos from the camera directory. On my phone the contact pictures are then stored as thumbnails in a thumbnail directory.
So far this is working, and I am sure there is some automatic way to do this, but I could not figure it out last night. Still getting used to the Cloud storing everything for me, and to be honest my computer (Windows) is not terribly friendly with Gmail. And Gmail itself is not terribly intuitive.
Craig