I am getting really frustrated as all of a sudden Lightroom has started opening the original DNG files for editing in Photoshop (CS5) instead of creating a TIFF file and editing that. I have checked all my settings and it still specifies TIFF as the edited file, it just doesn't work. I have tried restarting everything (computer, LR, PS) and every once in a while it will use a TIFF file, but 99 times out of a 100 it opens the DNG itself. The only think that has changed recently is that I updated to LR 4.1 RC 2 (previously had RC 1) - although I think it still worked after this update. Then I updated Adobe Camera Raw to 6.7... does anyone know if this is causing the problem and if so, how I can fix it?
Is the DNG opened in PS as a normal picture (not in the ACR dialoge!) with the title "xyz.DNG"? If that is the case, it is actually correct. When LR detects a compatible ACR (which happened after you installed ACR 6.7), it will pass the raw/DNG directly to PS without rendering a TIFF on its own. The file name indicated by photoshop is the original raw/DNG file then.
When you save the picture in photoshop, it will create the actual image file using the file type and other options (color space, bit depth...) you configured in Lightroom. So the outcome of the whole "edit in..." action is exactly what you want, with Photoshop creating the image file at the time you save it.
P.S. What happened before updating to ACR 6.7 was that probably sometimes before, the ACR compatibility warning dialog appeared and you chose "render using lightroom", causing LR to produce the TIFF file on its own and Photoshop to load that TIFF file, and consequently also displaying "xyz.TIFF". Now that LR considers ACR 6.7 as compatible, that behaviour is replaced with the new behaviour as described above - and the warning dialog no longer appears.