It's simple: OR gets precedence over AND. As a consequence, the query:

$ ls tags/grunge/AND/cover/OR/rock/AND/seventies/

should be read as:

((grunge AND cover) OR (rock AND seventies))

Can be translated in english as: list all the files tagged as grunge and cover together with all the files tagged as rock and seventies.The results set is built as follows:

1. take all the files tagged as both grunge and cover (first AND)
2. take all the files tagged as both rock and seventies (second AND)
3. merge the previous sets at 1. and 2. and list it (OR)