The Mysterious Cave is a dungeon that has a chance to spawn within the Dahlgur Oasis in Act II. The first level of the cave contains a Mysterious Chest which will drop the Liquid Rainbow used to craft the Staff of Herding.
Finding the Cave
The cave is associated with a merchant named Zaven the Alchemist. The alchemist will be cowering in front of what looks to be a boarded up door inside the face of a cliff. He is besieged by monsters, and if the player kills them, he will get a blue exclamation point over his head, indicating that he has something to say. After speaking with him, he will open up his wares for sale, and also open the door the Mysterious Cave. Zaven sells dyes appropriate to the difficulty level at half price to thank the player for saving his life.
The door, and the merchant, will only spawn on one specific map tile, and it is always at the southern tip of the zone. A general route, barring any unexpected randomosity, is pictured to the right. If Zaven and the cave do not spawn on this tile, nothing will replace it: the door will simply be barred, and there will be no monsters in the area. For farming purposes, the best way to see if the cave will spawn is for the player to head down the peninsula-shaped map tile and see if there are monsters present.
There is an alternate farming route, shown in the image below, but the secondary map tile isn't guaranteed to spawn, and there's no telling which map tile, if any, will spawn the Mysterious Cave.
The Mysterious Chest
The chest will be within the first level of the cave. The cave is similar to the Cave Under the Well, however it is much larger and more labyrinthine in layout. It may take some time to stumble upon the chest, but it will have the telltale yellow glow as a Resplendent Chest would, although it is named "Mysterious Chest" and drops nothing other than the Liquid Rainbow.
A Monk tasting the Rainbow.
Media
A video showing the route to the cave, and finding Liquid Rainbow: