FIXED
I took out the tranfer case position sensor (wrench 36 or plumber wrench) it's a bit difficult as there is not much space to move, I cleaned the piston on the sensor by soaking it in WD40 and by pushing the piston in and out for a couple of minutes.
The first time I pushed the piston I could feel the spring inside grindin a bit, after WD40 it moved smoothly.
And after I fitted the sensor again everything was back to normal.
The sensor is fitted on top of the transder case so it is a bit difficult for the transfer case oil to lube it and it will dry out and starts giving out wrong readings.
You can find the drawings for where to locate the sensor and how the sensor looks in the following link:
http://www.jeepkj.com/forum/showthread.php?t=34345