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In the gemstone trade, first water means "highest quality". The clarity of diamonds is assessed by their translucence; the more like water, the higher the quality. The 1753 edition of Chambers' Encyclopedia states "The first water in Diamonds means the greatest purity and perfection of their complexion, which ought to be that of the clearest drop of water. When Diamonds fall short of this perfection, they are said to be of the second or third water, &c. till the stone may be properly called a coloured one."
Heavenly jewels which Pericles hath lost,
Begin to part their fringes of bright gold.
The diamonds of a most praisèd water
Doth appear, to make the world twice rich.