At least I am pretty sure that is what it is. Drained the fluid and it was cherry colored and looked like a bass boat from all the small pieces of metal. A magnet would not pick up many metal so it was all alum. It makes a grinding noise around 2nd and 3rd gear shifts, sometimes it does it in other gears. Has not done it while going at highway speeds. Seems to only do it while the load is changing. Did a 4wd test down the road and it did not do it. Any suggestions and what would you guys recommend on a fix? Rebuild it or something else? 213,000 miles on it. Thanks

 

The transfer case oil is ATF so a red color is fine. The aluminum flakes are a problem. It could be your transfer case chain rubbing on the inside of the case. Or a failed bearing or snap ring. Either way with aluminum flakes and grinding noises you will have to open up the case to take a look.

 

It is the snap ring in the back of the transfere case that has broke I have had to fix this in mine.snap ring
This is one of them you can buy do a search on snap ring.

 

After searching snap ring and reading those posts, I believe that is my problem. Nice to think that I am not going to have to spend a bunch of money on a rebuild.