Heya mate!
I understand the concept of bounding boxes and alike. I also know from dabbling in 3D max at uni that there are alot of 3D deformation and 3D particle generation techniques that have been around for years that have yet to be included in real time 3D engines. For example volumetric lighting (which I see is coming in DX10 - farcry 2).
What im trying to say is, has there been a 'technique' developed that deforms objects in relation to them touching another object.
The water in oblivion is probably the closest to what im trying to say. The waves of the water react to the players movement, but not to environmental objects e.g where a stone boulder is in the water, the edge of the stone boulder and the edge of the water don't react properly. It looks like the water is a giant polygon with a deformation shader placed upon it (which it probably is and I imagine any other solution would be too complex for todays GPU's).
Another example is Unreal Tournament (the original). The Shock Rifle - you right click and shoot a ball of energy and then left click and shoot the energy ball creating a force that explodes from its centre outwards. If you shot it near a wall the animation of the explosion (flat texture animation?) was so big it would appear to go through a wall.
Other examples include, NPC's head and arms protruding through doors, Fire represented as two sprites that intersect each other creating the illusion of 3D - so bits of it stick into other objects, HL2's Bullets hitting water effects - not reacting with the water.
Do you think physx could possibly allow for such complex calculations?