search rags, and you will find a rosary, then go up once more and give the hermit the rosary.
Reward: You should receive item Emerald Medallion as reward although at this stage you cannot wear it, you need it I believe to help resist the effects of the Gremlin Confusion (Quest 138 - Gremlin Spirit).
Hermit says: Thank you my child, take this medallion which I found the other day, but can't seem to wear.
This is a small round medallion with a glowing green emerald in its center. A thin chain loops through the medallion allowing it to be worn around a persons neck.