I managed to solve the problem by uninstalling ruby with macports and 
reinstalling, following by rubygems via macports:

http://zeroeight.net/notes/archives/10-Setup-Ruby-and-Rails-on-Mac-OSX.html

(yes I am on osx, and yes I know its not a rails issue but thought I 
would post my solution anyhow)

Matt Jones wrote:
> Does this same error happen when you start up other Rails scripts (eg,
> script/console or script/server)?
> 
> The fact that it can't find rubygems seems to indicate something has
> gone seriously wrong with your Ruby install.
> 
> Here's some info that will help dignose (run at the command line,
> obviously):
> 
> which ruby
> which rails
> which gem
> gem --version
> 
> Also, are you manipulating the load path at all?
> 
> You may want to reply off-list, as this isn't really a Rails issue and
> I'll be able to reply faster.
> 
> --Matt Jones
> 
> On Aug 3, 12:56�pm, Adam Wilson <[email protected]>

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