I don't think something has went horribly wrong with your installation. I am experienceing the same problem as you since I upgraded iTunes. All my iTunes purchased media has a little cloud symbol next to it but when I open the album I find that I have to download the songs from the cloud.
Most annoying
. I checked the iTunes media folder and it would appear that all my stuff in that folder has vanished
I've connected my ipod now for the first time since the upgrade and it's telling me that there are items on my ipod that are not on itunes and now I've set it to download them to iTunes so hopefully this should sort the problem with missing media. UPDATE: connecting my ipod and syncing it has restored the music from the ipod to iTunes
Check out this page at
Apple Support Communities and specifically the post from rejoyce318 on how to get all the cloud media back onto iTunes easily
The following seems to have worked for me:
Get all the missing cloud media downloaded back into iTunes
Go to: Edit->Preferences->Store->Show iTunes in the Cloud Purchase
Untick this box and this will only show the media on your local PC or Mac.
I purchased a single after doing this and it downloaded ok into iTunes the way that it had done in previous versions of the software. Personally I don't use the cloud so having it turned on in iTunes is only confusing the matter for me