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SPOILER...
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...It's up in the Hills, at the site where you find the tavern, the mayor's house, and the mage's house. Head north and west until you find the tavern, then walk counterclockwise around the tavern. You'll find a wiseacre in the twelve o'clock position (compared to the tavern) who will offer rather acidly to tell you a story. Don't get nasty back, just listen. Then you can continue traveling counter-clockwise until you find the farmer and his chickens. Demand one of him, and if you're nice, offer him some coins. You'll get the gem.
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