I have created a windows 7 gadget which works properly when i copy it to %LOCALAPPDATA%\Microsoft\Windows Sidebar\
but when i zip it and rename it to .gadget and then try to install .. install confirmation screens comes but gadget doesnt get install.
You can download my code from: http://reliablesoftwares.com/100thmilaadcountdown.zip (its a simple countdown)
I've been having the same problem, and I think found what I was doing wrong. I was zipping up the gadget in a folder with the gadget's name instead of just the gadget files. I'm guessing that when you package your gadget, you're creating an archive from the gadget folder. Instead, you need to open the folder, and create the archive from the files themselves. In other words, the files (gadget.xml etc.) need to be in the top level of the archive. That fixed it for me, hope it solves your problem too.