It was the head gasket. In fact, shortly after my post, the gasket blew completely!
The mechanic checked out the head while replacing the gasket and found that the seals and one of the valves were worn. The blown gasket was caused by corrosion around no.6 cylinder on the head, so the head was resurfaced too.
With a new gasket, new seals and a new valve, the engine is now idling smoothly with only a hint of roughness - which I think may be a vacuum issue. The compression is also back on par.
1977 W123 280E
[This message has been edited by AucklandGuy (edited 08-31-2000).]