According to the Prima Guide, the Watcher's Blade requires 2 Consecrated Well Water, 2 Phosphorous, Adamantle, and 7 Ferrous. The Blacksmith doesn't have the Blade in stock, and neither of the heroes in this quest has the ability to collect the minerals. This quest involves Yacothia, and according to the Prima Guide, the Watcher's Blade is available in Yacothia. If the Guide is correct and if I understand the table right, the spy is supposed to trade a prisoner for the blade. But I have no idea how she's supposed to acquire a prisoner. There are no prisoners in the stocks, and I can't find any interaction that would allow her to acquire a prisoner.