Both #1 and #2 are grammatically correct. "Made out of" would also be correct. Even "made from" would be correct. There are subtle differences in connotation, though, which favor "made of".
Prepositions with make
When you make something—whether it be a cake, a shirt, a cabinet, or a true and mighty nation—usually you start with some sort of material. For example, to make a cake, you start with flour, eggs, and sugar. To make a shirt, you start with cloth. You indicate the material with a preposition. These are the most common prepositions for this purpose:
I made a cake from flour, eggs, and sugar.
I made a cabinet of maple wood.
I made a shirt out of dollar bills.
"From" suggests that the materials are consumed or transformed in the process of making the object, so they're not recognizable anymore, like what happens to the flour, eggs, and sugar when you make a cake. The materials were transformed from their raw state into the cake.
"Of" suggests that the material is still recognizable in the final object, like a cabinet made of wood or a shirt made of cotton. In phrases like "a cabinet of wood", "a man of character", "a novel of manners", "a nation of shopkeepers", the word "of" indicates something thought to be a deep, essential characteristic of the thing being described. It can't be changed without destroying or replacing the object.
"Out of" suggests a more radical transformation, like the strange idea of sewing dollar bills together to make a shirt.
None of the above are absolute rules or precise meanings. You could say "I made a cake of flour, eggs, and sugar" or "I made a cake out of flour, eggs, and sugar." Those are a little less fitting, because the core meanings of these prepositions (with "make") are as above. The core meaning of any word can be stretched, and the core meanings of prepositions in English often stretch a great deal.
Make without a preposition
As you already know, another way to use the word "make" is with no preposition at all, to indicate transforming one object into another, like this:
The new constitution of 1950 made India a secular and a democratic state. [Source]
Painting the walls a pleasant color can make your kitchen a warm and inviting place.
There are other ways to use "make" without a preposition, of course, but they're not relevant here. The important thing to notice is that the above phrasing suggests that the agent doing the making has great power to alter the original object by brute force or in an instant change. You can just get out some paint and paint the walls. The kitchen has no say in the matter. The material of the kitchen is not really important. The constitution of 1950 caused a huge transformation in India's government and legal system overnight. Again, this suggestion of arbitrary power over the object is not an absolute rule or precise dictionary definition; it's just suggested by this grammatical construction.
Now you can see why the writer favored "made of England". Here are the other main choices:
Elizabeth I made from England a true and mighty nation.
Elizabeth I made out of England a true and mighty nation.
Elizabeth I made England a true and mighty nation.
"Made from" suggests that the true and mighty nation hardly seemed to be England anymore, just as a finished cake doesn't look much like flour, eggs, and sugar.
"Made out of" suggests that England wasn't naturally well suited to becoming a true and mighty nation—that the transformation was maybe a bit like making a shirt out of dollar bills.
"Made" suggests, just a little, that Elizabeth performed the transformation herself, something like remodeling a kitchen.
Elizabeth I made of England a true and mighty nation.
calls upon the sense of "of" that suggests that the original material is still clearly present in the final product. It suggests that Elizabeth cultivated England's innate, already-existing capacity to become a true and mighty nation. It suggests that she acted more like a gardener, bringing out the seeds' natural potential to grow into plants, than as a kitchen remodeler. It suggests that the transformation was organic and profound, like the growth of a plant, not like repainting the walls in your kitchen. And it suggests that, after the transformation, the country was recognizably still England.
This is how prepositions and grammar work in English: there is no precise meaning or rule that applies consistently in all sentences. Instead, in order to communicate, people draw upon words and phrasings that evoke associations from commonly known, familiar phrases (making cakes from ingredients, cabinets of wood, etc.), and expect that you'll understand how those associations should be stretched to suit the sentence at hand. You pick a phrasing that most strongly evokes the familiar associations that you intend.