Nibali attacked his main rivals on the last of seven climbs in a brutal 161km stage from Mulhouse to finish 15 seconds ahead of local boy Thibaut Pinot (FDJ) of France.
Spain's Contador crashed on the descent of the Petit Ballon climb just sixty kilometres into the stage - and despite initially soldiering on the Tinkoff-Saxo rider withdrew from the race shortly after with a broken tibia.
Overnight leader Tony Gallopin (Lotto-Belisol) wore the yellow jersey with pride on Bastille Day - but the Frenchman came home 4:44 down on Nibali as the Italian returned to the top of the standings.
Nibali leads Australia's Richie Porte (Team Sky) by 2:23 and Spain's Alejandro Valverde (Movistar) by 2:47 going into the race's first rest day.
"My team worked incredibly throughout the stage and it was a great victory for me so I'm very happy," said 29-year-old Nibali, who celebrated by sucking his thumb in honour of his recently born daughter.
The Sicilian, a previous winner of both the Giro d'Italia and Vuelta a Espana, also said it was a "shame" that Contador had crashed out of the race.
Nibali attacked from a select group of favourites 3km from the finish, passing escapee Michal Kwiatkowski (Omega Pharma-Quick Step) before drawing level with lone leader Joaquim Rodriguez (Katusha) before the flamme rouge.
Spain's Rodriguez and Poland's Kwiatkowski - the white jersey - had been part of a nine-man break that formed early on during a relentlessly up-and-down stage that was once again hampered by early rain and fog.
Rodriguez crested the majority of the peaks in pole position - each time ahead of French veteran Thomas Voeckler (Europcar) - to ensure he would prise the polka dot jersey from the ample shoulders of Tony Martin, the previous day's stage winner who was also among the escapees after bridging the gap with team-mate Kwiatkowski on the descent of the Petit Ballon.
Rodriguez and Nibali rode together as the road flattened out before Nibali put in his decisive dig as the gradient rose to a gruelling 20 percent on the final ramp to the line. All chances of victory gone, Rodriguez sat up and eventually finished ninth on the stage, 52 seconds down on Nibali.
Tasmania's Porte - Team Sky's 'Plan B' leader following the earlier withdrawal of the initial race favourite, Chris Froome - had led the chase alongside French pair Romain Bardet and Jean-Christophe Peraud (Ag2R-La Mondiale).
In fact, although the stage victory narrowly eluded the host nation, it was a day of celebration for the French on their national holiday of Quatorze Juillet. Peraud and Bardet finished the stage in forth and fifth to put three French riders in the top five after Pinot's solid second place. The same trio also feature in the top ten - along with Gallopin, who drops from first to fifth.
American Tejay van Garderen (BMC) finished sixth on the stage, 22 seconds down on Nibali and three seconds ahead of Porte, who faded in the final kilometre. Van Garderen is now seventh on GC behind the Bardet-Gallopin-Pinot trio and ahead of Peraud, world champion Rui Costa (Lampre-Merida) and Dutchman Bauke Mollema (Belkin).
RIDER OF THE DAY: While Vincenzo Nibali underlined his credentials as the hot race favourite in the absence of both Froome and Contador, a special mention must go to Germany's Tony Martin. One day after Martin soloed to victory and the polka dot jersey, the powerhouse was at it again - this time in support of team-mate Michal Kwiatkowski, who at one point was the virtual yellow jersey on the road. A brave and awe-inspiring ride - perhaps even more so seeing that it ultimately came to nothing: Kwiatkowski popped on the final climb and dropped out of the top ten.
DAY TO FORGET: With Chris Froome crashing out before the cobbles, fans saw Alberto Contador crash out before the first HC climb of the race. The incident was not caught on camera but Contador needed more than four minutes of medical attention to a nasty gash on his right knee before getting back on his bike. He trundled on for 10km before reluctantly climbing into his Tinkoff-Saxo car. Now 31, the Spaniard may never get another better chance to add to his tally of two Tour de France wins.
COMING UP: A much needed rest day in Besancon ahead of Wednesday's rolling 187.5km stage into the Jura mountains, which concludes with four lower category climbs ahead of a downhill run into Oyonnax.
STAGE IN A SENTENCE: Nibali cements lead on queen stage as another one bites the dust.
- Sports & Recreation
- Tony Gallopin
- Joaquim Rodriguez
- Michal Kwiatkowski
- Thibaut Pinot
- Richie Porte
- Chris Froome