Grafting allows you to combine the special attributes of one item with the base stats of another.
Select an item with the special attributes you wish to use first, and the item with the base stats second. Click the Graft button. You will see a mock-up of what the new item will look like before you finalize it. If you approve of the mock-up, choose the Graft button again. You will select the Dwarven Coin(s) and then it is done. After grafting the second item will have the special attributes of the first item you chose, which is now destroyed in the process.
Grafting requires Dwarven Coins which can be aquired from daily task to attack monastry.
NB: The initial implementation of the Graft feature would wipe out any forged enhancements to the second item in the grafting process. However, today (7/24/10) I noticed that the forged enhancements would remain intact, but at the cost of many more (51 in my case) Dwarven Coins. So be warned....