My CONFIG_PROTECT is set, and contains /etc. I had installed from the 1.1a 16 meg iso image. I had added 8 ip / hostname lines to my /etc/hosts. After doing an emerge -u system, and world. my /etc/hosts was overwritten with a new one that just conatined the localhost / 127.0.0.1.
When I did it again, thinking that by some chance it was my fault. Again it killed /etc/hosts, but also modules.autoload, /etc/group and my /etc/conf.d/net were all overwritten. And again CONFIG_PROTECT was set. Hope this helps.
when you go from stage1 to stage2, the script 'scripts/bootstrap.sh' will kill all your config files ... its supposed to ... dont go setting up any variables/settings/etc... until after you bootstrap
Adding bug reporter to cc:
Haven't been able to reproduce this bug; closing.