Aurulite is dropped from mobs in any of the instanced dungeons in catacombs (they show on map as red doors, these dungeons can also be accessed from old lands (like the vendo caverns/spindelhalla ). The dungeons cover all level abilities right up to 50, with much more aurulite being dropped at higher levels. Then as you noted you can trade the blue stuff for armour, weapons and jewelry of fairly good quality for the level, the lvl 10 stuff costing as little as 4 pieces of auru and going up to 700 or so for the highest items.
Many people like the auru stuff for it looks as well.
heres a list of all the place you can find it:
http://camelot.allakhazam.com/item.html?citem=21554
and heres what the cloth version looks like (dyed purple, its usually light blue)
http://img99.imageshack.us/img99/7072/hexanna02je9.jpg
Edited, Aug 17th 2006 at 8:57am EDT by UrsanValrsgarde