(Adds analyst, paragraphs 6-7)

By Tim Cocks

KAMPALA, Nov 9 (Reuters) - Ugandan rebel leader Joseph Kony has arrested his deputy on suspicion of spying but denies executing him, a mediator said on Friday, amid intense speculation about the fate of a man instrumental to peace talks.

Ugandan media, quoting government intelligence sources, say Kony killed his second-in-command Vincent Otti about a month ago following a dispute over money and control.

Norbert Mao, a senior politician from Kony's home area, told Reuters he spoke to the fugitive head of the Lord's Resistance Army (LRA) by satellite phone at an undisclosed location in the remote forests of northeast Democratic Republic of Congo.

"He told me Otti is not dead," Mao said after talking to Kony. "He is only under house arrest because of a disagreement."

Otti -- who was seen as the brains behind the group, in contrast to the volatile Kony --was a prime mover behind the LRA joining peace talks that began last year in Juba, South Sudan, aimed at ending its 20-year insurgency.

Analysts said if true, the reports of his downfall were cause for concern.

"The reason the rumours are worrying is that there's a precedent. ... Several senior commanders have been executed after falling out with Kony during the course of the rebellion," said Matthew Green, the author of a forthcoming book on the LRA.

"Any uncertainty about what is going on at the top levels of the LRA is cause for concern, given the kind of leadership struggles that have threatened to split the group in the past."

Mao, speaking by phone from northern Uganda, said he believed the rift would not have a negative impact. "Kony understands that to take Otti out of the equation will not help," he said.

In neighbouring Kenya on Friday, an LRA spokesman insisted Otti was alive, but refused to say when he last spoke to him.

"PARANOIA"

Both Kony and Otti are wanted by the International Criminal Court (ICC) in The Hague for war crimes committed during their armed campaign against the government, which uprooted 2 million people in northern Uganda alone and destabilised parts of Sudan and Congo.

A truce was signed at the Juba talks in August 2006. But the LRA's top leaders have stayed hidden in Congo, fearing arrest if they show their faces.

Mao, a key player at the negotiations, said Kony told him he believed his deputy was a Ugandan government spy.

He said he had urged the rebel boss to remain calm.

"Movements like the LRA operate on paranoia," Mao said. "I told Kony he needs to deal with this internal disagreement without too much recklessness."

Otti often spoke to mediators and reporters by satellite phone from his hideouts.

But he fell silent in recent weeks and his various numbers went unanswered, prompting intense speculation about his fate.

Kony's first reported comments on Otti's whereabouts came as the LRA representatives at the Juba talks -- mostly members of Uganda's Diaspora -- toured the north of the country following a face-to-face session with President Yoweri Museveni in Kampala.

The rebel delegates are meeting local leaders and visiting camps for villagers displaced by the war, where they are trying to win support for their bid to scrap the ICC arrest warrants.

At a news conference in Nairobi on Friday, LRA spokesman Godfrey Ayoo said the rebel officials were welcomed everywhere.

He insisted Otti was alive and still a member of the LRA high command. But he repeatedly refused to answer questions from journalists asking when he last spoke to the LRA's number two. (Additional reporting by Daniel Wallis in Nairobi) (Writing by Daniel Wallis; Editing by Mary Gabriel)

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