To the northeast of the Water Town of Saria, there is a cave that will contain the Water of Life. Before entering, you need to obtain the Hammer from Death Mountain to break the rock in front of it. When you collect the Water of Life, head over to the Harbor Town of Mido and give it to the Old Woman near the fountain.
For reference here's a Mases video, the cave starts at 7:25:
[video=youtube;PkOLRVXJYr4]http://www.youtube.com/watch?v=PkOLRVXJYr4&feature=relmfu[/video]
And a map with the the Town of Mido's location, the Hammer's location, and the cave's location labeled: