"The big ship sank to the bottom of the sea"
Seems to rule out a canal(unless it was after the end of the canal)
My nan (who's family were all either dock workers or in the Merch) always led me to believe it was the Atlantic that was being refered to, I have no proof of this only hearsay of course.
This would also rule out the theory that it is a nonsense song. There seems often to be a rush to assume children's songs are nonsense. However, as we know quite a few are based in fact although using words that MAY not quite make sense.

OB