Using dnsmasq with NetworkManager
It is possible to override settings by putting them into /etc/NetworkManager/dnsmasq.d/*.conf. Configuration file settings take precedence over command-line flags. They are applied when NetworkManager starts dnsmasq. Run sudo service network-manager restart to reapply. (If there's any doubt: brad's answer missed the fact that ps ax | grep dns shows a --conf-dir argument)
For example:
echo cache-size=1000 |sudo tee -a /etc/NetworkManager/dnsmasq.d/cache.conf
As I recall NetworkManager disables dnsmasq caching by default due to concerns over cache poisoning. For a machine where all users are trusted it may not be an issue.
NetworkManager doesn't integrate with resolvconf, and NM's server at 127.0.1.1 won't be used locally if the resolvconf package is installed. resolvconf is part of ubuntu-minimal and standard Debian installs; NetworkManager reimplements that functionality in a more integrated, less script-based way.
NetworkManager does make sure not to interfere with a global dnsmasq instance (binding to a secondary loopback IP and setting bind-interfaces through /etc/dnsmasq.d/network-manager). If you install a global dnsmasq instance and keep NM's instance, double check in /etc/resolv.conf to see which one the host will use by default.
While you can customise NetworkManager's dnsmasq instance as shown above, if you want a DNS server that binds to public interfaces, you should install the dnsmasq package (NetworkManager only uses dnsmasq-base, which doesn't configure a global instance) and put your configuration in /etc/dnsmasq.d/*.conf. NetworkManager's slave instance is only meant to bind to the loopback interface and configuring it beyond that scope would risk breaking it.
In summary, for someone who just wants local DNS caching:
sudo apt-get remove dnsmasq resolvconf dhcpcd5 rdnssd
echo cache-size=1000 |sudo tee -a /etc/NetworkManager/dnsmasq.d/cache.conf
For a simple LAN, NetworkManager's connection sharing should still suffice. But for a custom-configured LAN, with TFTP and so on:
sudo apt-get install resolvconf dnsmasq
echo 192.168.0.50,192.168.0.150,12h |sudo tee -a /etc/dnsmasq.d/lan.conf
echo enable-tftp |sudo tee -a /etc/dnsmasq.d/lan.conf
sudo service dnsmasq restart
I also have your problems.
In principle, after wiki.archlinux, it seems that to enable caching it should be enough to create a file /etc/NetworkManager/dnsmasq.d/cache containing simply
$ cat /etc/NetworkManager/dnsmasq.d/cache
cache-size=1000
I tried this but, after NM restarted, I still have no cache:
# ps ax | grep dns
11724 ? S 0:00 /usr/sbin/dnsmasq --no-resolv --keep-in-foreground --no-hosts --bind-interfaces --pid-file=/run/sendsigs.omit.d/network-manager.dnsmasq.pid --listen-address=127.0.1.1 --conf-file=/var/run/NetworkManager/dnsmasq.conf --cache-size=0 --proxy-dnssec --enable-dbus=org.freedesktop.NetworkManager.dnsmasq --conf-dir=/etc/NetworkManager/dnsmasq.d
Note that the cited conf-file is always empty: I have not been able to configure any option using this procedure.
All in all, it seems that the NM-enslaved dnsmask in 14.04 (which is provided by the dnsmasq-base package) is completely locked, so it is not possible to enable caching, nor anything else (dhcp, tftp).
If this is right I think that, as you say, the only solution to the problem is to disable the NM-drive dnsmasq by commenting out the line
dns=dnsmasq
in the file /etc/NetworkManager/NetworkManager.conf and install the "standard" dnsmasq and then configure it via its standard /etc/dnsmasq.conf configuration file.