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China, the world’s largest wheat producer, is facing a severe drought in areas of the North China plain that account for 67% of the country’s wheat crop. China’s wheat production fell to 114.5 million tons in the 2010 harvest from 115.1 million tons a year earlier. This year the harvest could drop another 4 million tons.

This is a big deal since China is also the world’s largest consumer of wheat and accounts for about 17% of global wheat consumption.

The government is working to provide additional irrigation to mitigate the drought.

In Western Australia—across the continent from Australia’s worst floods—drought has put the wheat crop in Australia’s largest wheat producing state in doubt. The impact of the decade-long drought itself is intensified by a battle for Western Australia’s scarce water supplies between farmers and miners. There are about $170 billion in new mining projects on the books for the next five years. All those mines need water to help dig out and process ore, to remove waste rock and to suppress dust. Mining is already the largest user of water, taking 27% of licensed water, compared to 22% for agriculture. Six years ago the proportions were reversed with farming getting 37% of water and mining 26%.

I think you can see where I’m going with this, right?

No, no. Not more about the increasing global squeeze on food supplies. I’ve dealt with that quite enough recently, thank you. (See my posts and )

This time I want to talk about water scarcity, the trend that everyone sees but that it is so difficult to invest in. I’m going to give you some stocks to use to invest in water—but not my usual 10 since, as I said, this is a difficult trend to invest in. And I’m going to suggest out how finding investment opportunities in water can serve as a model for other difficult to invest in trends, such as food.

Let’s start with the basic problem—the world on average has plenty of water. But the actual location of supplies, population, pollution controls, and incomes and the very local nature of water make that average meaningless. According to the World Health Organization (WHO), in 2009 about 20% of the world’s population lived in countries without enough water for their needs. The World Bank does the calculations in a different way: 80 countries now have water shortages that are sufficiently dire to threaten health and economic activity.

And the situation is getting worse. Growing populations, rapid urbanization that concentrates more people in less space and that often eats up farm land, rising and competing demands from farming and mining, increasing pollution of water supplies, and climate change that is exacerbating the severity and frequency of droughts—all these will stress water supplies even more in the future.

  According to the UN Food and Agricultural Organization, by 2025, 1.8 billion people will live in countries or regions with absolute water scarcity and two-thirds of global population will be under what the agency calls “water stress conditions.”Human beings being what human beings are all that stress is likely to lead to conflict. More than a dozen countries—including Botswana, Bulgaria, Cambodia, the Congo, Gambia, the Sudan, and Syria—get the majority of their water from rivers that flow across the borders of hostile neighbors.

The biggest potential problem, though, is in Asia. Both China and India face severe water shortages due to fast economic growth, rapid urbanization, and pollution. According to the World Bank, China could face a supply shortfall of 201 billion meters of water by 2030. (That’s about 53 trillion gallons, by the way.)

Many of the rivers that supply the bulk of water to India, Cambodia, Vietnam and other countries in the region have their source in mountainous areas inside China’s borders. China has been rapidly constructing dams on many of these rivers and the region does not yet have a mechanism for resolving conflicts over water supplies.

And, of course, since most of the world’s water goes to agriculture—about 70%, according to the United Nations with 22% going to industry and 8% for domestic use—the current food crunch is going to raise tensions further. Nothing like being thirsty and hungry to make countries cranky.

So how does the world fix (or at least ameliorate) this problem? And where do the investment opportunities lie?

First, and most obvious answer: Increase supplies. The easiest—although very expensive—way to do this is to turn sea water into fresh water. It’s easy because constructing a desalination plant is a well-understood engineering task. It’s expensive because building the plant will run $2 billion or so and because it takes about 14 kilowatt hours of electricity to produce 1,000 gallons of water. If you’re looking for a desalination stock look at the big engineering and construction companies. My pick, because desalination is as key business for the company and because it has good penetration in markets in the Middle East and Asia, is Singapore’s Keppel (KPELY in the United States and KEP.SP in Singapore.)

Second  answer: Move water from where it is to where it’s needed. Hard over extremely long distances but again just an expensive engineering problem over short and medium distances. You’ll need lots of pumps and valves to get the job done: My favorite pick here is Flowserve (FLS).

Third answer: Use water more efficiently. Big U.S.-style center pivot irrigation systems are efficient if you’re measuring them against the cost of having your crops dry up and blow away in a drought. My pick here is Lindsay (LNN). (For more on Lindsay, a Jubak’s Pick, see my original buy post ) If you want a more efficient way to irrigate, drip methods get the nod. The biggest player here is Jain Irrigation Systems. Unfortunately, the stock currently trades only on exchanges in India (JI.IN) and Luxembourg (JAISE.LX.)

Those three suggestions make up the simple answers. From here you have to get creative to invest in water.

Fourth answer: Change the economics of water. Much of the world’s water supply, especially, most surprisingly in the world’s developed markets, is un-priced because it’s unmetered. (On the other hand, if you buy your water by the gallon from a water carrier in a under-developed economy, it is most certainly priced.) I can’t think of another scarce commodity where the consumer doesn’t pay more for using more. To change this, developed countries have to add more water meters. Two meter makers that I like are Badger Meter (BMI) and Itron (ITRI).

Fifth answer: Invest in sectors where the scarcity of water is driving up prices of what that other sector produces. The biggest of these in the case of water is food. Fertilizers, form this point of view, become a secondary play on water shortages because farmers who have water when other farmers don’t see rising revenue and rising incentives to increase production. Among fertilizer producers I like potash producer Potash of Saskatchewan (POT) and, even more, the diversified fertilizer producers Agrium (AGU) and Yara International (YARIY).

It’s this last point—my fifth answer—that I’d like you to keep in mind when you’re scouting around not just for a water investment but for an investment in any tough to invest in sector. Scarcity and surpluses ripple out from their sources in one sector to change growth and profitability in other sectors. So water ripples out to food. Or rising aluminum prices ripple out from the aircraft and auto sectors into the carbon fiber industry.

These secondary plays won’t go up initially as fast as the more obvious thematic plays, but the fundamentals will eventually assert themselves in share prices.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did own shares of Agrium, CVH, Deere, Flowserve, Keppel, Lindsay, Syngenta, Vale, and Yara International as of the end of December. For a full list of the stocks in the fund as of the end of December see the fund’s portfolio at