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No one is entirely sure how to interpret the text this rumor came from. In the issue of Famitsu where XSIII was announced there was a piece of text that translated to something along the lines of "The end of the Xenosaga trilogy" -- this is where most of these rumors are originating. The line is rather vague and could easily imply that episode 3 is just the end of a story arc (i.e. the end of the first trilogy), OR it could imply that it is the end of the series as a whole. The running theory seems to be that it's been left vague intentionally so that Monolith can argue either interpretation depending on how well the third episode sells (i.e. if it totally tanks they can say that they meant it was the end and that way no one will think the series was cut short -- the end looks planned/intentional; but on the other hand if it sells decently or even well they can argue that they just meant it was the end of the first story arc and that the series will continue).

It's also still arguable as to whether Xenosaga is directly connected to Xenogears or not. I'm not going to argue the point, because at this time I don't think we have enough information to make any conclusive judgements on this topic.