If you're getting significant play in the shaft of the t-case rear output, I think you've answered your own question.

Also, don't neglect the possibility that you may have two different problems. One may be causing the noise, the other may be causing the shavings.

1977 CJ-7, fiberglass body, AMC 360 w/ headers, DUI ignition, Edelbrock intake and Holley 4150 carb, TF999, Dana 300, 4.56 gears lockers, York air comp, 4" susp lift, 2" body lift, BFG 35" M-T tires, Megashifter, AGR pump & box, REP8000 winch.