If you've spent any time researching Canon's HD DSLR cameras, you've probably come across discussions of which of the cameras' ISO settings to use and which to avoid. There seems to be a common misconception out there, held by even some very well-regarded experts (http://www.zacuto.com/shootout, webisode 2, about 3 minutes in) that the cameras' "native ISO" or "true ISO" settings are the multiples of 160 (ISO 160, ISO, 320, ISO 640, etc), and that the rest of the ISO settings are produced digitally. This is not true. In fact the cameras' native ISO settings (that is, the settings that are derived from analog gain rather than digital exposure compensation) are the multiples of 100 (ISO 100, ISO 200, ISO 400, ISO 800, etc). However, that doesn't necessarily make them better.
I believe that much of the confusion comes from mis-analyzing tests such as these:
that clearly show that the 160-multiple ISO settings exhibit less noise than the 100-multiple ISO settings. Viewing these test results is often surprising to people because it goes against the conventional wisdom that the higher the ISO, the noisier the image will be, and the lower the ISO, the cleaner it will be. In fact, it is very surprising to learn that ISO 1250 can look on par with or even better than ISO 125. The natural assumption when looking at these tests is that the native ISOs must be the cleanest ones. This seems like a logical assumption at first, but it doesn't hold up when you look at it a little bit closer.
It makes sense that noise would increase if you added a digital push to the exposure, but if the lowest native ISO is 160, and all other non-native ISOs exhibit greater noise levels due to a digital exposure push, then how are ISO 100 and ISO 125 derived? Also, what about the Canon Rebel T2i? It does not offer any intermediate ISO settings, but only allows the selection of the 100-multiple ISOs. Given that this camera is so similar to the 7D, it seems much more likely that they would simply eliminate the intermediate (non-native) ISO choices than that the camera's sensor would be somehow fundamentally differently designed from that of the 7D and 5D Mark II.
So, if the 160-multiple ISOs are not the native ones, why are they cleaner, and how are they derived? Well, it is correct that the 125-multiple ISOs are the noisiest because they are derived by a digital exposure push. ISO 125 is actually ISO 100 with a 1/3 stop digital exposure push, ISO 250 is ISO 200 with a 1/3 stop digital exposure push, etc. However, the 160-multiple ISOs are actually the cleanest not because they are "native", but because they are a result of a digital exposure pull. This pull brings down the exposure of the entire image, and hides much of the noise that would be visible at the next higher ISO. ISO 160 is the cleanest because it is the native ISO 200 with a 1/3 stop digital exposure pull, yielding even less noise. ISO 320 is actually ISO 400, with a 1/3 stop exposure pull, etc.
So now that we know this, which ISO settings are best? Just because 160, 320, 640, etc, are not "native" does that mean you shouldn't use them? Well, no, not necessarily. They are less noisy, after all. It's just important to understand that there is a price to pay for this lack of noise. That price is decreased dynamic range.
Because ISO 320 is actually ISO 400 pulled 1/3 of a stop, that means that the highlights are going to clip at exactly the same point as they would at ISO 400. The 1/3 stop pull is just making that point 1/3 stop darker than pure white. The entire image at ISO 320 is 1/3 stop darker (and may be less noisy) than the image at ISO 400, so the blacks lose detail 1/3 stop sooner, but you don't get that 1/3 stop back at the highlight end of the range -- it's still gone. Therefore, at ISO 320 you're losing a net 1/3 stop from the total usable dynamic range that you would have if you were shooting at ISO 400. The tests here confirm that this is the case: http://www.cryptobola.com/PhotoBola/Canon7D_ISO.htm. [Update: these tests no longer seem to be online.]
So which is more important, shooting images with less noise, or shooting images with more dynamic range? It's obviously subjective, but for me there is no one-size-fits-all answer. In some cases I prioritize one, and in some cases I prioritize the other. I really can't think of any reason to use the digitally pushed ISOs (125, 250, 500, etc). If you need more exposure, you're better off going up to the next exposure-pulled ISO, or the next native ISO, rather than shooting with the increased noise and decreased dynamic range that comes along with the pushed ISOs. In general, if I am shooting a bright scene with a large contrast range, such as a daytime exterior, I will prefer to use the full-stop, native ISOs. In that situation, since I will likely be using the lower ISOs (100 or 200), noise really isn't much of a factor anyway, and I will prioritize dynamic range to prevent the highlights from blowing out as much as possible. If I am shooting a dimly lit scene, I will likely be using the higher ISOs where noise is more of an issue. In that case, keeping the highlights in check isn't usually a problem, so I will prefer to use the 160-multiple ISOs (320, 640, or 1250) so I can get more exposure with less noise.