I pulled the rear cover off and the detent ball and spring were there and looked OK. The lower unit grease that came out of the cover had small metal particals mixed in the grease. The clunking noise I hear when hand spinning the prop when in netural position seems to be comming from the upper housing area. The prop will lock up in forward or reverse when hand spinning the prop but in netural there is this clunking noise. I ran the boat in the water all week end and it worked OK, but I am nervious.

I split the upper and lower gear housings. With them apart the and turning them both (the upper and the lower) there is no noise. I took the coupler put it onto a broom stick and turned the upper gear case/clutch and no noise. So I bolt the two case back together and less noise but still a clunk noise. As I torqued the bottom case and the upper down back come the clunk...when you pre load the input shaft bearing on the lower gear case the clunk appears. Any ideas??

I dont like the idea that you found metal in the upper, or anywhere for that matter..
But the clunking you are hearing, I believe is the upper clutch shaft moving up and down, taking up slop. It is normal to have that. Usually you dont hear it when the drive is full of oil. First time I heard it.. I though something was wrong. But looking into it, I found that when the top cap goes on it will free up the clutch shaft some and allow it to clunk if you rock the prop shaft back and forth..
Now about that metal.. was it fine dust or flakes and chunks?? The latter is a problem.

No chunks and just a small particals/dust. When I drained the grease tonight I drained it from the bottom there were a few particals on the magnet of the drain screw/plug.
So you do not think there is anything wrong with my lower prop shaft gear case?
When my gear cases are bolted together the clunking sound reminds me of an old Alpha drive in gear and some spinning the prop backwards....it is a real clunk clunk clunk...with every turn of the prop. It is not back lash noise.
The bearing that I am talking about it on the input shaft of the lower gear case...to perload it you have to bolt the upper and lower cases together...that is when the clunk noise comes back.

Ended up finding a bad/rough bearing on the input shaft of the lower gear case. There are two bearing on that shaft and the top bearing was rough only when it was per loaded by bolting the cases together. I took the lower to a Merc dealer and they had a bearing plate to perload the bearing with the lower off of the upper. Once we installed this test plate you could feel the bearing. The shop replace the two input shaft bearings and all is working OK now!!
Thanks
Mike

?????????????