Book 2, Part 13: In this unfortunate chapter, Sancho loses his island, which he finds to be under attack.  Though he's down for the entire battle, his side seems to win.  Nonetheless, he decides that he's not cut out to be a governor, and thus resigns his post.  On the trip back to the duke's castle, he encounters his former neighbor, Ricote, an exiled Morisco.  Eating with Ricote and his band of renegades, Sancho learns that they are searching for some kind of buried treasure. 
Finally, Sancho leaves the group, only to fall into a hole in the ground, which he discovers is actually a cave.  Eventually, Don Quixote, of all people, finds his long lost squire, and the two are happily reunited.  Sancho explains that he could no longer handle the pressures of governing.  The Don is somewhat happy that Sancho can now fulfill his duties as his squire, and the two reassume the traditional roaming lifestyle of knights and squires-errant. 
Book 2, Part 14: Quixote, happy to be free again, tells his squire, "Liberty, Sancho, my friend, is one of the most precious gifts that Heaven has bestowed on mankind." Next, ironically enough, the Don tactfully implores Sancho to whip himself, hoping that his reluctant squire may begin to work off some of his obligation to Lady Dulcinea.  Throughout the chapter, Cervantes pokes fun at the phony author of the Quixote sequel, criticizing his portrayal of the Don and his peerless Dulcinea. 
Later, they head to Barcelona, where Quixote resolves to beat Sancho himself, though the squire doesn't allow it.  Soon they are confronted by a host of both dead and living bandits, one of whom, Roque Guinert, is a Robin Hood kind of figure.  The Don and his squire spend three days with these men, with whom they reach Barcelona. 
In the city they are treated as royalty, though eventually Quixote finds himself confronted by the Knight of White Moon.  Strangely, this knight seems suspiciously like the Knight of the Wood, only this time, the Knight of the White Moon (Samson Carrasco) wins, mandating that Quixote return to his home for the span of at least one year.  Sancho and his dejected master head for home.