I think that's a bit of a stretch. They existed in a better state than Jews did in Christian Europe but did not live anything akin to what we would consider to be equal rights
today and I doubt they 'happily' existed. I'm sure you wouldn't want to wear clothes now which marked you out as a Muslim for example or have to pay an extra tax compared to your next door neighbour Bill.
Circumstances have obviously also greatly changed in terms of power in the Middle East and how Arabs and Muslims see themselves compared to the rest of the world.
Do I think the Arabs would actually exterminate the Jews if they had the upper hand? For various reasons, I don't, though you never know the depths of the human mind. It isn't exactly a stretch to imagine why Israeli Jews may be concerned about this though, considering some of the rhetoric which has been used in the past to frame the conflict in the Middle East itself.
@2cents has spoken of the importance of getting both sides to understand andf empathise with each other, if a solution is ever to be found. I can't see how a Palestinian would ever be able to understand the processes that led up to the Nakba, even with the horrible events that preceded it. They can try to understand the feelings before and after though, as well as vica versa.