I've started to experience the gem bug in MM1. I know it only happens when I am trading, but what am I supposed to do when my Knight or Robber pick up gems? They are useless on them.

But what has happened with me is my Cleric being at 509 gems, my Robber at 297 and trading only 10, and then finding out my Cleric only has 263 gems left.

As it only happens during trading, I know I will have to get most of my gems by drops, which is fine. But I hope you can get them quickly through drops, then. And it's not a slow crawl. My question is what are the creatures I should look out for? And are the amount of gems that drop dependent on your level?

Wish there was a way to direct which character to pick up the gems.

I still haven't played MM1, but:
* From what I recall in MM2, fairy type enemies drop them there, and I would expect spellcasting enemies to drop them.
* Avoid trading gems if doing so would cross a multiple-of-256 boundary. In your example, you could prevent this by waiting until your Cleric has at least 512 gems, then trading the gems (but don't go above 768 in this case!). Alternatively, wait until you get close to the lower boundary, but not lower; in your case, if you had between 256 and 501 games, the trade would not have caused that glitch.
* If you *really* dislike this bug are good with x86 assembly and debuggers, get a heavy debug build of DOSBox or another emulator with debugging capabilities and change the 8-bit add to a 16-bit one. (The hard part is finding the offending instruction; once you do, changing it should be relatively easy.) Once you do, you might want to post the edit you made so that other players can benefit from this. (I've done this sort of thing before, but not on this particular game.)
* (Also, I believe MM1 NES may have capped your gem count at 255, but then again, that version has the nasty Locust Plague bug.)

Sprites, Ghouls, Hags, Demons, Devils, Gargoyles, Spiders, Centaurs, Pegasus, Clerics are a few of the monsters who can drop gems.

Don't waste time bothering about the gems, you already have more than enough so it doesn't matter if a few are lost or lying in a non-caster inventory. About 30 percent of the monsters drop gems, so you will have enough for casting when needed.

Ah yes, that makes sense. I passed that 256 number boundary with my Cleric (512) so it reduced my gems. What I think I am going to do is just trade right up to those 256 boundary amounts (256, 512, 768, etc) and wait until they get gems as loot to push them above that boundary. And then trade with them again up to the next boundary.

As for fixing the issue, yeah, I'm not the person to do that. lol I wouldn't know the first thing about how to do that, but thanks for giving the info on how to do so. :)

You said you've played MM2, does the second game also have the gem bug issue? Gems haven't been an issue right now, but I know when I get higher level spells (6th and 7th) I will go through quite a bit more gems and want to have them so I can cast those spells without worry.

I don't remember MM2 having this particular issue, but that game is definitely not bug free. In fact, it's so buggy that, when trying to exploit one exploitable bug a different bug gets in the way!

The main negative issues with MM2 seem to be that overflows can occur at high levels (somewhere past 200 IIRC, stopping at level 20 or so is perfectly reasonable in MM2) and that a weapon enchanted to +63 can be considered cresed by the game. (Also, before you ask, the Uncurse Item spell will not fix that item; that spell actually sets the number of charges remaining on the item to 1 instead of working as the description says; also cursed items don't otherwise appear in MM2, anyway.)

The other thing in MM2 is that permanent stat changes are often not reflected in the temporary value; you need to fight a battle or rest before they become apparent. (Also, do not steal Murray's treasure, or if you do, rest and then check your stats before going back to the inn; I mention this because this can easily ruin one's fun with the game.) The gem costs of spells don't go that high; there are only two spells that cost more than 5 gems to cast.
* Divine Intervention, which costs 10. If it's like MM2, this spell can only be cast once per battle, and it ages the caster 5 years, so it's not a spell that you will be using constantly. (Hint: After going to the inn, leave and cast Rejuvenate before quitting the game, and if it backfires, just turn the game off.)
* Duplication, which costs 100. While it's a nice spell, it's not something you'll be constantly using, and its main purpose may actually be to give you some use for those gems you end up not using. Even if you're cloning a charged item (and remember Recharge Item exists), if the charges are copied (they are in MM2 but not MM3) you can charge the item *before* you duplicate it. (By the way, in MM2 Recharge Item can overfow if it rasies the charges past 255, and it's possible that MM1 may have the same bug, but do you really need *that* many charges?)

That's a shame there are still so many issues/bugs with MM2, but then I don't plan on going level 200+ if it is easily defeatable well before that.

But how easy is it to enchant a weapon up to +63? Or is it another one of those situations of going level 200+ (where it's really not needed)? Again, if +63 is ridiculously high/difficult to get to, it's not a bug I'm too concerned with.

The permanent stat change issue doesn't seem to bad. Just rest and then it takes effect, instead of just immediately.
As long as it becomes permanent after that rest (or fighting a battle). It's hard to say how quickly I will burn through gems until I get those 6th and 7th level spells, but I know that all the spells at those levels will always require gems when casting them. I can see myself casting Disintegration or Meteor Shower a lot as my main spell with my Sorcerer and Moon Ray/Sun Ray with my Cleric a lot, as well. I guess it depends on how quickly I attain gems at that level.

Duplication doesn't seem like something I really need to cast all that often, or even a spell that jumps out "I need to cast" at all. Unless I get a REALLY nice magic item that has charges and I want to make sure I never use up the item (charges). But then I have the spell Recharge Item, as well.

Level 200 is not necessary. In fact, since enemy parties grow in size as you level, I would recommend that you stop at level 20 or so (at least for permanent level; there are items that can temporarily raise your level to make certain fights easier if needed). There are ways to boost your stats independently of level, including one spot that gives you plenty of hit points (and the Max HP potion can give you some temporarily anyway).

Enchanting an item from +62 to +63 requries that you have at least 3100 SP, which you can't get until a very high level (don't know how high off hand), and is not necessary.

The stat issuie isn't that bad if you are aware of it, and as long as you don't steal Murray's treasure. (Again, if you want to do it just to see what happens, rest and then check your stats *before* you go save at the inn.)

Edit: In some versions, ehchanting an item +63 is a lot easier, requiring only 113 SP for that last point. This is true in the Sega Genesis version and I believe the classic Macintosh version, but is definitely not the case for the MS-DOS version you get from GOG.