Editor's Note: Jon D. Markman writes a weekly column for CNBC on MSN Money that is republished here on TheStreet.com.


Biotech, energy, steel and semiconductors have charmed investors with their muscular start to the year. But there's one little group that has paradoxically been on fire this year, and it may be the most liquid investment opportunity in the world.

With an introduction like that, you just had to figure that I am referring to the most humble natural resource in the world, and that is water.

Did I say humble? Maybe not so much anymore. A brand-new exchange-traded fund designed to track the performance of water stocks, the PowerShares Water Resource Portfolio ( PHO) -- which tracks the PowerShares Palisades Water Resource Index -- is up a whopping 15% so far in 2006.

That swamps the performance of the red-hot AMEX Biotechnology Index, up 8% this year; the Philadelphia Semiconductor Sector Index, up 6%; the iShares Dow Jones U.S. Basic Materials Sector Index, up 3%; and the 2% advance of the iShares U.S. Energy Sector Index. And if your mom ever told you that clean water was as precious as gold, she was at least right this year, as the Philadelphia Gold and Silver Sector Index is only up 3%, or five times less than water.

The Must-Have Commodity

What's behind the move? A key attraction of water as an investment is that demand is accelerating and is not affected by inflation, recession, interest rates or changing tastes. You can live without steel. You can live without oil. You can live without gold. But try living without water, and you won't last too long. About eight to 10 days, by most estimates.

The problem is not that the world is running out of water. Scientists seem to agree that there is pretty much the same amount of water on the surface of the planet now as there was 10 million years ago, as physical forces ranging from respiration to precipitation replenish the supply and maintain hydrobalance. No, the problem is that drinkable surface water is increasingly polluted because of the urbanization of rural areas and industrial farming, particularly in the developing world and China. And all the while, there are simply a lot more people who want a sip.

When you look at the Earth from outer space, you see a lot of water. But less than half of 1% of it is fresh; the rest is either seawater or frozen in the polar ice caps. The United Nations, which will celebrate World Water Day on March 22, reports that the consumption of water worldwide is doubling every two decades -- twice the rate of world population growth. Already, 1 billion people do not have easy access to drinking water. By 2025, the U.N. figures that 2.7 billion people will suffer from severe water shortages.

If you think world conflict over oil has been bad, wait until you see major fights over water rights. The worst conflicts are projected for arid Africa and the Middle East, where Israel, Syria, Jordan and Lebanon dispute rights to draw fresh water from the Sea of Galilee and the Litani River and Turkey and Iraq battle over the Tigris and Euphrates.

Meanwhile, in the Central Asia regions of Uzbekistan and Kazakhstan, communist-era planners ruined the freshwater rivers that fed the once-fertile basin of the enormous Aral Sea and turned the area into a toxic dustbowl. And in China, damming and pollution have damaged numerous key waterways, including the very important Yellow River. The list goes on and on.

Each of these regions is scrambling after scant solutions. The U.S. is not immune. In the Plains states, local governments fight over access to water from the country's largest aquifer, the Ogallala. The underground stream running from Texas to the Dakotas irrigates around 20% of the nation's crops; it is rapidly being drained, as rainfall has not kept pace.

Farmers are looking increasingly to crops that do not need as much water, such as soybeans.

Green Rain

So how do you invest in a solution for the water crisis? It's a little trickier than the energy or precious-metals business, as there really aren't any explorers, drillers or pipeline operators. Because of water's critical role in our health, almost all U.S. and European water is held and managed by regulated utilities whose growth rates and expenses are capped by government fiat.

Although a few have done exceptionally well for investors -- such as Southwest Water ( SWWC) and Aqua America ( WTR) -- most are primarily purchased for their safe dividend yields.

The best way to play water is probably through the companies that supply pollution-control, purification, pipeline construction and irrigation-control products, though there's nothing wrong with owning a couple of successful water utilities as well. Consider the following list of 20 stocks from the Palisades Water Index for a six-month to one-year holding period.

20 in the Water
Market cap. Industry Last price
Itron (ITRI ) $1.4 billion Scientific instruments $59.62
Danaher (DHR ) $18.7 billion Building materials $61.65
IDEX (IEX ) $2.4 billion Diversified machinery $47.97
IDEXX Laboratories (IDXX ) $2.5 billion Diagnostics $79.02
General Electric (GE ) $350 billion Conglomerates $33.28
Aqua America (WTR ) $3.7 billion Water utilities $29.59
Pentair (PNR ) $4.0 billion Diversified machinery $40.81
California Water Service (CWT ) $806 million Water utilities $44.25
Southwest Water (SWWC ) $392 million Water utilities $18.21
Roper Industries (ROP ) $3.9 billion Diversified machinery $45.69
Valmont Industries (VMI ) $894 million Farm machinery $37.23
Insituform Technologies (INSU ) $718 million Heavy construction $27.25
Watts Water Technologies (WTS ) $1.1 billion Industrial equipment $36.69
Pall (PLL ) $3.7 billion Diversified machinery $29.86
Emerson Electric (EMR ) $34 billion Industrial equipment $83.13
3M (MMM ) $55.8 billion Conglomerates $74.20
Saneamento Basico (SBS ) $2.2 billion Foreign utilities $19.85
Ashland (ASH ) $4.7 billion Oil & gas refining $65.76
Consolidated Water (CWCO ) $296 million Foreign utilities $26.23
Flowserve (FLS ) $2.8 billion Diversified machinery $52.61

Itron ( ITRI) has been on a tear lately, pressing up against its all-time high, so it's one to consider on a dip. The company provides meter technology to utility owners that helps them collect and analyze data about customer usage. Earnings growth has been exceptionally strong of late, at about 18% a year. With its price/earnings multiple now at 24 on estimated 2007 earnings, it's definitely not cheap. But it's exactly the sort of thing that straight-up growth managers buy, especially now that it is emerging toward mid-cap status.

Aqua America, the premier public water utility in the U.S., was recommended last year as well. It has continued to grow at a 12% pace, rapid for a utility, via acquisitions. Its valuation is quite stretched now at about 30 times 2007 estimates, which only goes to show how few vehicles there are for institutional investors to get exposure to water. Aqua serves 2.5 million customers from Pennsylvania to Texas and will report earnings next week. Technically, shares on Monday broke out of a six-month consolidation to a new all-time high.

There are a couple of initial public offerings in the sector to keep an eye on as well. Not long from now, Walter Industries ( WLT) will spin off Mueller Water Products.

Walter, whose own shares are up 50% in the past six months, bought Mueller last summer for $1.9 billion with the expressed intention of spinning off its water products unit that specializes in supplying pipes, hydrants and valves for municipal water companies. Because engineering infrastructure is a hot investment area right now, the IPO should be well received. Put it on your watch list.

Meanwhile, industry analysts at Stanford Washington Research Group have noted that German conglomerate RWE AG is expected to spin off its American Water Works unit, which is said to be the largest U.S. water company, with an enterprise value that could reach as high as $5 billion. It's not known if RWE will sell the company to the public via an IPO, sell it in pieces to existing utilities or sell it to a private equity firm. In any case, don't look for any final word until much later this year.

Another deal that could be on the horizon, according to Stanford: French-based Suez ( SZE) may spin off its United Water unit, which could add another $2 billion company to the sector in an IPO. Both companies lost their independence to the Europeans six years ago, and their return could generate new frothiness in this otherwise rather dull group.
At the time of publication, Markman had no positions in stocks mentioned, although positions may change at any time.

Jon D. Markman is editor of the independent investment newsletter The Daily Advantage. While Markman cannot provide personalized investment advice or recommendations, he appreciates your feedback; click here to send him an email.

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