You may want to try setting piping_material_file as well as pro_material_dir. It could be that PTC was attempting to split the piping materials off from the regular material files but forgot to update the documentation for piping_material_source.
Right now the documentation for piping_material_source says that if material_dir is set as the value, then the location used in pro_material_dir is used. Maybe they meant to change it to piping_material_dir but it got missed. Try it and let me know if that works.
I'd say if that doesn't work, you should re-check your pro_material_dir location. Make sure you're pointing to a directory. If none of that resolves the issue, you may need to call PTC and open a call. It could be that this option is simply not working right in your version of Creo (or Pro/E).