guys please once visit the mobo site where gigabyte is saying it has Intel GMA x4500, Microsoft DirectX10, Intel® Clear Video Technology.
then why 1080p mkv 2 hours long video of 4gb is not being played by me mobo.
I have installed all the latest drivers.
There isn't much that you can do other than decreasing the resolution. As you already determined, the issue occurs whenever the CPU is 100% busy. For smooth playback you should get a better CPU and a good video card wouldn't hurt either. An old E6600 or E6700 will be twice as powerful as your current CPU and they aren't that expensive on eBay.
In VLC, Go to Preferences, then the "Input & Codecs" Tab, you should see a Option Called "Skip H.264 in-loop deblocking filter"
It is a enhancement for low-quality videos, but it may lag in HD Videos.
Change it to "All" Then it shouldn't lag anymore.
I find it wierd that you have LAG with HD Videos since My laptop with a Core Duo and GMA 950 doesn't lag with 1080p videos...