Does anyone know what this does? I can't find much documentation other than that it "automatically connects objects as they are created" or somesuch. i created some new objects with it turned on and nothing in particular happened.

If you put an object, type its name and click outside it to create it and immediately after that, without clicking or typing anything else, you create another one (object, message, it won't work with GUI though), it will connect them, creating the second about ten pixels below the first one.
In the beginning it might be problematic as you'll might accidentally connect object you don't want to connect, but eventually it's quite handy and makes patching easier and faster.

...especially if you have a habit of adding an object by ctrl+1 shortcut.

how does it know which outlet to which inlet? Does it only do it if there if only one of each?

I think it always performs "output 0 of last object to input 0 of just created object".