I have heard that a circular link can hurt rankings, but am not exactly sure what that is. I hope it's not a link from home page (index.html) to product page (product.html) then a link from product page back to home page. This is especially confusing, as I have also heard that a page may be penalized if it links to your home page, but homepage does not link back (i.e gateway page, junk page).
I do understand the hidden links from index page to sitemap.html, etc. theory, was really just worried about creating 'circular links' and being penalized for it. What are they?
When most people are talking about circular links they are referring to Site A linking to Site B, Site B linking to site C and Site C Linking to Site A. It really only becomes an issue when you interlink every page of every site to every page of every other site, even then, some think that the "circular link penalty" is a non-issue.
>>I have also heard that a page may be penalized if it links to your home page, but homepage does not link back
Stop listening to those people. ;) Then take a look at the navigation structure on some well-ranking sites.