"On the fly" gunzipping actually DOES seem to work - it just appears that only LOCAL streams/files (including php://stdin) can be accessed for some reason. I THINK (but have not yet tested) that you could similarly gzopen "php://stdout" and pass a stream of gzipped data to the browser (when run from a web page) or console (when run standalone) through there.
I HAVE tested scripts from the command line like:
wget -q -O- ftp://some.host.net/pub/some_gzip_file.gz | php gunzip_stuff.php
where gunzip_stuff.php would be a script that gzopened "php://stdin" and did gzgets from that stream, and it seems to work fine, but that obviously doesn't help someone wanting to grab gzipped streams from remote sites from a web-based script.
Being able to read gzip streams from ftp and http is near the top of my personal wishlist at the moment...