I'm of the opinion that Ageia may ultimately fail BUT nVidia and ATI will take up where they left off with more simpler physics routines initially that adds a little bit to physics processing. This will in turn become more complex as time goes by. After all, we're getting close to the limit on how far a tradtional GPU can get better without it becoming a bit ho-hum.
To me, current graphics cards are nearing the limit on how desirable the new features will be in another year or two. I mean, more polygons, whee, faster shader processing, whee, higher resolutions, whee, more graphical effects, whee, higher frame rates, whee. What's after that? What new features are going to make it compelling to purchase new graphics cards? I mean, once you get past a certain level of graphics effects and can get a steady 60fps+ on it, then what? I can easily see a 2560x1600 resolution at 60fps being done by graphics cards in 2 years with all the features you see on current cards and then some. I feel most graphical improvements after that will be incremental and not compelling enough for most gamers to upgrade until full photo realism in 3D is achieved.
I agree that more realistic physics will be the next big thing. I'm just not sure a $200-300 add-on card will be that. It seems much more realistic that ATI and nVidia (or maybe Matrox rising back from the grave) will be able to do that. Imagine a FPS where you could literally blow holes through walls to make a new entranceway if you don't feel like walking in the front door and you got a rocket launcher. Grenades and other explosions would make holes in the ground, allowing you to make your own trench. Blowing up small buildings and killing everyone inside as the roof collapses instead of having to shoot everyone individually. All in a realistic manner. The biggest boon could probably be to MMORPG's with superb world realism, though they'd have to limit how much you can impact the environment.