Upon playing around more with the hook-up, my problem seems to be something to do with the DC power that is feeding the XM Skyfi2 radio. If I keep the AUX cable plugged in and unplug the power to the XM radio (either at the dock jack or at the cigarette outlet) the AUX mode on the headunit STAYS! As soon as I reconnect power to the XM radio, the AUX mode cuts out and disappears as long as the powered-XM radio is plugged in. It does not matter whether the radio is "on" or "off" - as long as the power adapter is plugged into the XM and the XM is plugged into the AUX, my AUX mode will not work. (This is very strange, since this same exact set-up does not affect the AUX mode in my 2003 MINI.)
I also experimented with powering the XM radio using the 'home kit' AC adaptor. When the SkyFi2 is powered by the AC adaptor, there seems to be no problems of the AUX cutting out. AUX mode is selectable on the head unit, and it does not cut out.
So my conclusion is the DC power adaptor may be a source of interference that is causing the AUX to cut out when the XM SkyFi2 is all plugged in. Somehow this interference creeps into the audio path and reaches the head unit via the AUX input. The newer head units may have some circuitry that cuts off the AUX source if it senses a 'dirty' signal being sent in, even though what we hear does not sound 'dirty' at all.
My next experiment turned out to be the solution to this problem. I went to Radio Shack and bought a Ground Loop Isolator (SEE THIS
). This device was installed in place of my mini-stereo audio cable, between the XM SkyFi2's line-out and the AUX jack. I also needed a Y-Adaptor (SEE THIS
) to convert the mini-stereo jack into RCA jacks to connect to the ground loop isolator. Upon installing this, my AUX mode returned as an available source on the head unit. It also did not cut out again. I believe this device filters or cleans that 'dirty' signal that kept causing the head unit to cut off the AUX source when my XM SkyFi2 was plugged in.