A good way to find the bay is through the mayor, start from where he is and walk west (If the sun/moon is setting, that's west. If the sun/moon is rising, you're facing east). Then just say somewhat near the coast until you get to the bay.
Once there, a message should pop up saying you've arrived, and at some point a building should show up. The best way to do this is run in there, right click the package and get through the dialogue, and run out as fast as possible.
Once out of pirate bay and out of harm, run back to and talk to the smith again (If you forget he is in the building with smoke).