Diane's dream is a replay of her Sexual abuse
David Lynch's last clue is "Where is Aunt Ruth?" It's the last clue for a reason: it's the most important of his clues in understanding the fundamental nature of MD. Where is Aunt Ruth? Well, in a sense, she is everywhere. First we see who we believe to be Aunt Ruth at 1612 Havenhurst: a well-dressed red-headed lady with a scarf on, and a taxi driver helping her with her bags. Then look at the airport while Betty is saying goodbye to the old couple. Who walks by around the taxi zone? A well-dressed, red-headed lady with a scarf on, and a man accompanying her, carrying her bags. And then at Sierra Bonita Betty and Rita watch a well-dressed red-headed lady with what appears to be a scarf around her, with a man carrying her bags to a limo or towncar.
But where else is Aunt Ruth? I'm just going to flat out tell you: Hell (well, sort of). Let me explain.
First of all, in the dictionary the word "ruth" is described as "grief; repentance; regret." This is key. I was always a believer that Diane was abused as a child, most likely by a family member. Not only because of the clues in the film, but also because of the prevalence of child abuse in Lynch's films. However, I was never really convinced that her abuse was central to the film's meaning, until now. Diane's uncle or father (or whoever) sexually abused her as a child, and Aunt Ruth knew about it. Diane threatens to tell someone what's going on, but Aunt Ruth couldn't bear the secret to be let out, so she makes an agreement between the two of them. If Diane keeps quiet, she can have some (or all) of her aunt's money when she's gone. ("Silencio." There are those who believe one of the greatest sins there is is silence.) Diane's agreement to be silenced is not just for the money, of course. The primary reason is because Aunt Ruth has put things in her mind to make her feel guilty about it ("If you're trying to blackmail me, it's not going to work." ... "And what about you? What will your dad think about you?")
The constant appearance of an Aunt Ruth-like character always packed and on the move in her dream could represent either Ruth's unwillingness to help Diane in her time of need or Diane's unwillingness to accept the fact that they had an understanding over such a traumatic thing. (Coco: "You and your Aunt probably have an understanding, so here's the key.") Diane is given the key to Aunt Ruth's stuff because Aunt Ruth is dead, just like Diane is given another key because Camilla is dead. This answers another one of Lynch's 10 clues: Who gives a key, and why? Also, could two family members ever have an "understanding" in a Lynch film without it having a darker meaning?
Why is Aunt Ruth in hell? Well look on the flyer on the lamppost where Betty and Rita get into the black cab (a little bit of an ominous sign) to go to Club Silencio. The only readable word on the flyer is in block letters: "HELL". I believe Diane gives herself a glimpse of Hell, or what she perceives Hell to be. On the parking lot of Club Silencio is a figure 8. Turn it sideways and it's the symbol for infinity, showing that we are now entering a realm of eternity.
After Betty and Rita are seated in the club, the Magician starts talking. I believe the Magician is the Devil, or Diane's perception of the Devil. He is actually a pretty silly Hollywood stereotype of the Devil, just as the Cowboy is a silly stereotype. The Magician speaks at least three other languages. The Devil's many tongues is a frequent description of him. He has a goatee like most of the standard, stereotypical depictions of him. He has a large wand which could act as his pitchfork. He can perform magic. And, well, his grin as he disappears behind smoke doesn't exactly say, "Nice to see you. How're your folks?"
When the Magician says, "Listen," thunderous sound fills the room, and blue light (symbolizing her abuse, just like it does in "Fire Walk With Me") fills the theatre. This is Diane's idea of silence being broken, and she quakes with fear, but afterwards appears relieved, as if a weight has been lifted.
The reason for the Magician speaking English, Spanish, and French? He is speaking to three people: Betty, Rita, and Aunt Ruth. Aunt Ruth is associated with French because inside her apartment is clearly seen the book "Tout Paris", which is a guide to the art of French decoration. Is the book a definitive answer to Aunt Ruth having French blood? No, but I think its possible significance shouldn't be overlooked.
Next, the Blue-Haired Lady is Aunt Ruth! What about the hair, you ask? Well, the club is pretty much all red, just like her hair, but you'll notice that the club sometimes is flooded with strange blue light. As Aunt Ruth has the only balcony seat, we can assume that she holds a special place in the club, and therefore her hair has turned from red to blue (she has been tainted with the guilt of silence). Where is her scarf? First, I think it would be a dead giveaway if Lynch gave her a scarf. Everyone would know it was Aunt Ruth. I think the scarf might be a symbol of her pride which forces silence upon Diane, and when she is sent to Hell she is stripped of that pride and forced to feel how wrong she was.
Finally, the film ends with the line, "Silencio," a reminder to both Aunt Ruth and Diane that the abuse and subsequent silence has, indeed, been "the end of everything."