I see this issue with Gusty, Hardy and other distros.  Similar to the
original poster, my configuration for testing is:

  Internal HDD: Not for Linux (yet)
  External USB HDD: Install to here

Boot from the LiveCD/DVD.  The internal drive is considered hd0, the
external drive is hd1.  IMPORTANT CAVEAT: you must use the advanced
button to tell the installer to put the boot loader on hd1.  It silently
defaults to wiping out the boot sector on hd0, even though you've not
asked it to touch hd0.  That will infuriate a lot of unsuspecting users,
and really needs to be fixed.

In any event, after booting, you can use the grub option to edit the
boot line, and fix it from the hd1 that the drive was during install, to
the hd0 that the boot drive becomes.  Yes, same drive, the hd<x>
assignment changes.  That's the behavior.  So you then edit menu.lst to
fix all hd1 references to hd0 (including the commented out one that is
the default, else the next kernel update will put you right back in the
same situation), and either remove or correct any previously existing
hd0 references (to the internal drive, which would have been hd0 during
installation).

I've been doing installs to USB every few weeks (the Ubuntu test build
release cycle), and am quite used to it, but this really should be fixed
(both the drive assignment *and* the blowing away of the internal
drive's boot sector without warning).

-- 
upon installation the GRUB menu.lst file is generated wrong
https://bugs.launchpad.net/bugs/127946
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