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Honda's Melandri secured his fifth career victory in a time of 44 minutes 15.62, 9.69 seconds ahead of Suzuki's Chris Vermeulen after rain on lap 10 and the first instance of mid-race bike changes this season turned the contest on its head.
Vermeulen won Australia's first home podium place since multiple world champion Mick Doohan won the 1998 race, and Rossi snatched third with an audacious pass on the final corner at the expense of Spain's Sete Gibernau.
World championship leader Nicky Hayden, who slipped from pole to 16th after a poor first lap, recovered to clinch fifth while Spain's Dani Pedrosa, second in the standings before the race, came 15th.
Hayden moved to 225 points in the standings, 21 clear of the charging Rossi with three races to go. Melandri climbed into a share for third with Pedrosa on 193.
Rain was in the air at the Phillip Island circuit when the race began and Kawasaki's Shinya Nakano made a blistering start, opening up a seven-second lead after seven laps when the rain began to fall harder on lap eight.
NASTY TUMBLE
Yamaha's Colin Edwards spun off with a nasty tumble as the riders started to flood the pit for a chaotic change to bikes with slick tyres.
When the field sorted itself out, Gibernau led from Vermeulen with Melandri not too far behind. The Italian took the lead on lap 16 from Gibernau and never looked back.
"I almost fell over myself on the change of bikes. It was difficult when we left the pits, a little scary. I saw Vermeulen and Sete going fast so I thought maybe I could too," Melandri told reporters.
"I said to myself be smooth because it will be difficult for everyone."
While Melandri was easing away from Vermeulen and Gibernau, Rossi overtook Hayden and Aussie Casey Stoner on lap 18 to go fourth before starting the job of reeling in the leading trio.
His efforts looked forlorn at the start of the final lap but somehow Rossi, winner of the last five Australian grands prix, got on the wheel of the Spaniard and overtook him with the line in sight.
"I lost a lot of time with the rain tyres but I think that was my fault," Rossi said. "It was just on the last corner and it was so important. I take second place in the championship with three races to go, we will be trying for sure."