Got it sorted. It turns out .netnuke has to many directories so the directory monitor runs out of memory (limit of 256MB) because it creates a monitor for each directory.  The registry change below changes .net's behaviour to create one monitor per webapp and uses that to monitor the directories under it.
For anyone else having the problem here's what I did:

1. Create a user who will run the .netnuke app pool and who has modify access to the unc path
 1.1 Modify security permissions so the user can run the app pool.
 1.1a C:\WINDOWS\Microsoft.NET\Framework\v2.0.50727\aspnet_regiis -ga <user>
 1.1b gpedit.msc  (Local Computer Policy/Computer Configuration/Windows Settings/Security Settings/Local Policies/User Rights Assignments)
  Grant "Adjust memory quotas for a process", "Logon as a service" and "Replace a process level token"
2. Create the app pool and set the identity
3. Create the website with the home directory as the remote share and app pool as created above
4. regedit HKLM\Software\Microsoft\ASP.NET create DWORD "FCNMode" value 2  (This was part of a hot fix but what the document doesn’t say is it also applies to .net sp1 and above)
5. iisreset

refrences:
http://support.microsoft.com/kb/911272
http://msdn.microsoft.com/en-us/library/ms998297.aspx
http://beyondthispoint.blogspot.com/2006/04/setting-up-iis6-application-pool.html
 

You can also try this path (it worked for us)

http://support.microsoft.com/kb/221790/ 

if you read it all you see the following behaviour:
windows 2000 has by default 125 worker connection threads
with Sp1 it goes up to 65536 and then the gentle people of microsoft gave us server 2003 and the default was 50.

so raising
[HKEY_LOCAL_MACHINE\SYSTEM\CurrentControlSet\Services\lanmanworkstation\parameters] "MaxCmds"=dword:00000800 on the IIS client server
and
[HKEY_LOCAL_MACHINE\SYSTEM\CurrentControlSet\Services\lanmanserver\parameters]
"MaxMpxCT"=dword:00000800
"MaxWorkItems"=dword:00002000

on the fileserving server could do the trick.