From the A.Word.A.Day mailing list
first water (furst WA-tuhr) noun
- The highest degree of quality in a precious stone, especially diamond.
- The best grade or quality.
"Anne-Sophie Mutter: The German
-born former prodigy
was once known more for her strapless gown
s and her glamor
, but she has matured into a musical diamond of the first water."
Melinda Bargreen, "Strings of Success," The Seattle Times
, Jan 17, 1999
All the sources I can find says the origin of the phrase is in diamonds' quality being measured by their translucency -- the most like the clearest water, the highest-value. One source points out that oddly enough, this phrase was often used negatively: "He is a cad of the first water" meaning he was the most extreme kind of cad.
http://www.word-detective.com/052598.html and http://www.shu.ac.uk/cgi-bin/tp_post4.cgi?=137550)