Transparency in Windows Forms is kind of broken. As you have discovered, it doesn't really support overlapping controls; it just shows the form's background color through the transparent parts. With some Windows API magic, you can make many controls display as truly transparent with support for overlapping, as this article by Bob Powell demonstrates. I've been able to make his technique work for labels and custom controls, but I think I've tried to make it work for PictureBox
with disappointing results. One workaround could be try create a custom control that manually draws the image; I haven't tried. Here's a forum post where I demonstrate a custom control that supports true transparency (my handle on that forum is AtmaWeapon.) My memory seems to suggest that this works best for custom controls due to some apparent magic that happens with Microsoft's controls when they are rendered.
Alternatively, you could implement your application using WPF instead of WinForms. WPF's transparency works and supports overlapping controls. This is a pretty big shift in how you'd develop your application, but it works from the start.